What it means
At its simplest a CBLO was a secured overnight loan with a middleman. The borrower pledged government securities to the clearing corporation, the lender's cash was advanced against that collateral, and the resulting obligation to repay was the instrument that changed hands.
The problem it solved was access. Many mutual funds, insurers and smaller institutions were not permitted in the interbank call money market, so they had nowhere safe to park surplus cash overnight, and institutions with spare collateral had no easy way to borrow from them.
Pricing worked much like any other money market borrowing: a rate was discovered on the exchange, usually close to the central bank's short-term policy corridor, and interest accrued for the number of days the money was out. Most trades ran for a single day, with maturities stretching to a few weeks at the longer end.
Because the clearing house novated every trade, meaning it stepped in as the counterparty to both sides, lenders had no exposure to the borrower at all. That is why these rates sat below unsecured call money rates, and why volumes were large relative to the rest of the money market.
The instrument was wound down and replaced by triparty repo, which does the same job under the standard international repurchase framework rather than a locally designed contract. For a non-specialist the practical point is that both are secured, centrally cleared, very short-term lending, so what you learn about one carries straight over to the other.
In practice
Real-world examples.
Example
A debt fund receives a $25,000,000 subscription an hour before the market closes and has no suitable bond to buy that day. Rather than leave the cash in a current account earning nothing, the dealing desk lends it overnight against government collateral at 7.3% and earns exactly $5,000 for the night.
Example
A bond dealer holds a large inventory of government securities and needs cash for three days to settle a client purchase. Pledging part of the inventory costs less than selling bonds and buying them back, so it borrows against them and keeps its market position intact.
Example
A treasury analyst at an insurer is asked why the secured overnight rate in a board pack is lower than the unsecured call rate. She explains that the secured trades are collateralised and centrally cleared, so the lender carries no credit risk on the borrower and accepts a thinner return in exchange for that safety.
Formula
Calculation
Interest on a CBLO borrowing = Principal x Rate x Days / 365
The figures below use dollars for consistency with the rest of this glossary, although the market itself dealt in Indian rupees. A mutual fund lends a bank $10,000,000 overnight through the facility at a rate of 7.3%. Interest for one day is $10,000,000 x 7.3% x 1 / 365, and because 7.3% of $10,000,000 is $730,000, dividing by 365 gives exactly $2,000. The fund therefore receives $10,002,000 the next morning, and the borrower's pledged government bonds are released once repayment settles.Case study
Seen in the real world.
Sahana Capital is an invented asset manager used for this illustrative example. Its short-duration fund regularly ended the day with idle cash because subscriptions arrived after the bond market had thinned out, and the dealing desk had been leaving the balance in a bank current account.
The treasurer worked out that an average idle balance of $8,000,000 for roughly 200 business days a year, lent overnight at around 7%, was worth close to $307,000 of forgone income. Lending it secured through the central facility also removed the question of which bank the cash was sitting with, because the clearing corporation, not a single counterparty, stood behind the trade.
The fictional lesson is that the gain came from process rather than cleverness. Nothing about the fund's strategy changed, only the default home for cash at the end of the day, and the desk kept the same ability to buy bonds the following morning.
Watch out
Common mistakes.
- Reading CBLO as a type of bond an investor can buy and hold, when it was a short-term secured lending arrangement between institutions.
- Assuming the collateral passed to the lender, when it sat with the clearing corporation and returned to the borrower on repayment.
- Quoting CBLO as a live instrument in current market commentary, when the facility was discontinued and triparty repo took over the same role.
Questions
People also ask.
Who was allowed to use the facility?
Banks, primary dealers, mutual funds, insurers, pension funds and some corporates, which was the point of it, since several of those groups were shut out of the unsecured interbank market.
Why were the rates lower than unsecured overnight rates?
Because the borrowing was backed by government securities and guaranteed by the clearing corporation, so the lender took market risk on the collateral rather than credit risk on the borrower.
Is CBLO still worth learning about?
Yes, because its replacement works the same way and the term still appears in older annual reports, policy papers and professional examination material.
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