The Treasury of a Scheduled Commercial Bank is analyzing its structural liquidity and interest rate sensitivity using various derivative overlays to maintain the Net Interest Margin (NIM) within the board-approved limits. In a scenario where the bank has a significant portion of its assets in floating-rate infrastructure loans linked to the 6-month MIBOR and its liabilities in long-term fixed-rate retail deposits, which of the following derivative strategies correctly utilizes an Interest Rate Swap (IRS) to mitigate the resulting mismatch while accounting for the current Indian regulatory landscape?

Question

Accepted Answer

The bank should enter into a Pay-Floating and Receive-Fixed Interest Rate Swap to convert its floating-rate assets into fixed-rate equivalents, thereby matching the fixed-rate nature of its liabilities.

Answer

The bank should execute a Forward Rate Agreement (FRA) for a period of ten years to lock in the interest rates for the entire duration of the infrastructure loans, as FRAs are the primary tool for long-term hedging in India.

Answer

The bank should utilize a Basis Swap to exchange its 6-month MIBOR receipts for 1-year G-Sec yields, as this completely eliminates the credit risk associated with the corporate borrowers of the infrastructure loans.

Answer

The bank should enter into a Pay-Fixed and Receive-Floating Interest Rate Swap to ensure that any rise in the cost of fixed-rate deposits is offset by the increasing receipts from the floating leg of the swap.

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