What Is a Collateralized Borrowing and Lending Obligation (CBLO)?
A collateralized borrowing and lending obligation (CBLO) is a money market instrument that represents an obligation between a borrower and a lender concerning the terms and conditions of a loan. CBLOs allow those restricted from using the interbank call money market in any given specific country to participate in the short-term money markets.
Key Takeaways
- CBLO is a money market instrument that represents an obligation between a borrower and a lender.
- The instrument works like a bond where the lender buys the CBLO and a borrower sells the money market instrument with interest.
- The term, the interest rate, and the specifics of the CBLO are often all negotiable between the two parties.
- A CBLO is much like a Treasury bill or very short term market instrument; the primary difference is a CBLO entails collateral in the transaction.
How a CBLO Works
CBLOs may exist around the world, though they are most common in India. In that context, CBLOs are operated by the Clearing Corporation of India Ltd. (CCIL) and the Reserve Bank of India (RBI). CBLOs allow short-term loans to be secured by financial institutions, helping to cover their transactions. To access these funds, the institution must provide eligible securities as collateral—such as Treasury Bills that are at least six months from maturity.
The CBLO works like a bond—the lender buys the CBLO and a borrower sells the money market instrument with interest. The CBLO facilitates borrowing and lending for various maturities, from overnight to a maximum of one year, in a fully collateralized environment. The details of the CBLO include an obligation for the borrower to repay the debt at a specified future date and an authority to the lender to receive the money on that future date. The lender also has the option to transfer his authority to another person for value received.
Since the repayment of loans is guaranteed by the CCIL, all borrowings are fully collateralized. The collateral provides a safeguard against default risk by the borrower or lender’s failure to make funds available to the borrower. The required value of the collateral must be deposited and held in the custody of the CCIL. After the deposit has been received, the CCIL facilitates trades by matching borrowing and lending orders submitted by its members.
Special Considerations
Types of financial institutions eligible for CBLO membership include insurance firms, mutual funds, nationalized banks, private banks, pension funds, and private dealers. To borrow, members must open a Constituent SGL (CSGL) account with the CCIL, which is used to deposit the collateral.
Collateral
The clearing corporation must often specify a list of eligible securities that quality for collateral. That entity may also specify the maximum amount any single security can be contributed. The borrower must ensure that its exposure on the deals are always covered and secured by the collateral it has provided. There may be other collateral requires, for example, as outlined by specific guidance documents by entities such as the Clearing Corporation of India Limited.
Maturity
The typical maturity of a CBLO can vary but generally falls within the short-term range. CBLOs are designed for short-term borrowing and lending transactions in the money market. The typical maturities for CBLOs may range from one day to one year, though the most common maturities are in the overnight to about one week.
There is often oversight into CBLOs and their terms. For example, the Reserve Bank of India has outlined a number of maintenance requirements and regulatory precedents.
Interest Rate
The interest rate specified on a CBLO is typically determined through a negotiation between the borrower and the lender at the time of issuance. The interest rate may be set based on a variety of factors which may include but aren't limited to:- The creditworthiness of the borrower. Borrowers with stronger credit histories may be able to secure funds at a lower rate.
- Market interest rates. The prevailing rates mostly established by short-term government securities often set the general direction of rates.
- The competitiveness of issuance. CBLOs may be issued through a competitive bidding process where multiple borrowers bid to secure funds from lenders. In such cases, the interest rate is determined by the lowest bid that fulfills the lender's requirements.
- Relevant reference rates. Some CBLOs may use reference rates, such as a benchmark government security yield, as a basis for setting the interest rate. The rate may be quoted as a spread above or below this reference rate.
- The specific agreement. Once the borrower and lender agree on the interest rate, it is specified in the CBLO documentation, along with other terms and conditions of the transaction. This rate may or may not be related to any bullet above.