Introduction:
The overnight market is a part of the money market where very short-term loans are made, typically lasting only one day (hence "overnight").It's mainly used by banks and financial institutions. They assess their expected cash requirements for the day, borrowing if they anticipate a shortfall or lending if they expect to have extra funds. The overnight rate, or the interest charged on these short-term loans, is a crucial factor in this market. Other financial institutions may also participate for similar reasons.
How does it Works:
Lenders in this market agree to lend money to borrowers, and the borrowed amount, along with interest, must be repaid at the start of the next business day. Most of the action in the overnight market happens in the morning, right after the start of the business day. The interest rate in this market, known as the overnight rate, is usually the lowest at which banks lend money.
What is the Overnight rate in India?
In India FIBL-Overnight MIBOR rates are used for Overnight borrowings. It was introduced on July 22, 2015 by RBI, FBIL stands for Financial Benchmarks India Limited, and MIBOR is the Mumbai Inter-Bank Offer Rate.
It's an updated version of the MIBOR benchmark, specifically designed for overnight transactions. The introduction of FBIL in the name indicates that it is administered and published by Financial Benchmarks India Limited.
Okay, But how it is calculated?
FIBL-Overnight MIBOR rates are calculated using BENCHMARK methodology in which a minimum of 10 trades with a total traded value of Rs.500 crore in the NDS-Call segment is the threshold for such rate estimation. Outliers (trades significantly higher or lower than the average) are excluded from the calculation.
A rate range is computed, with a maximum (Max) and minimum (Min) based on the weighted average rate and standard deviation. Any trades outside this range are considered outliers and excluded.
However if the threshold criteria are not met, the computation time frame is extended. If still not met, the previous day's values are used for reference. This may continue for a maximum of two consecutive working days, after which, if criteria are not met, no rate is publicize.
But how does Overnight Money market rates affects borrowers?
When the overnight rate goes up, it becomes more expensive for banks to settle their accounts. To cover these increased costs, banks may raise the interest rates on longer-term loans thereby increasing the EMIs and hence our cost of borrowing increases.
