(An Autonomous Apex Institute Established by RBI & Banks)
(An Autonomous Apex Institute Established by RBI & Banks)
Paper Number :WP51/2025
Publication Date :March 7, 2025
This paper examines the integration of the Indian FX Swap market, highlighting liquidity risk that can spill from international to domestic markets and may affect the liquidity across different tenors of the FX Swap segment. This paper argues that even under a managed float exchange rate or pegged exchange rate, the real economy faces systemic risks linked to the forex interbank segment's liquidity exposure, despite the central bank’s efforts for the stability of the exchange rate. Using ARDL model, the study finds that the domestic FX Swap market is significantly integrated, especially in the 1-month tenor, where banks use swaps to hedge client positions regularly. The 6-month tenor is crucial for establishing derivative contract reference rates, while the 12-month tenor serves as a key market benchmark influenced by interest rate differentials between India and US Treasury rates. Furthermore, the FX swap market demonstrates integration with some Asian economies and the US, particularly between India’s managed float and Singapore’s pegged exchange rate. Overall, the liquidity in these markets FX Swap interbank segment fosters global connectivity, which may impact the liquidity of the banking sector. Despite supervisory efforts by the Basel Committee, the self-regulated nature of the interbank market means that individual banks’ risk appetites dictate overall exposure levels.