Adventures in the Money Markets: The Rise of Godzilla

Money markets are the inter-bank market for short term borrowing and lending. Banks manage their strategic asset–liability mismatches as part of their overall long term plans for raising deposits and making loans. Short term reality however rarely tracks long term execution and tactical money market operations are necessary to mange the short term fluctuations of the balance sheet. Normally the money market desk of a treasury is considered boring, with excitement belonging to the currency desk. But once in a while a situation can develop that would challenge the most aggressive of currency dealers. This is the story of such a deal. Comfort with arithmetic is required.

Let us set the stage. All commercial banks in the UAE must, by Central Bank (‘CB’) regulation, maintain a dirham account with the CB through which they clear their dirham transactions. For example, if a customer of bank A transfers AED 100,000 to his vendor’s account in bank B then bank A transfers AED 100,000 from their CB account to bank B’s CB account. Bank B then credits the vendor on their system.

Now this is where things begin to get interesting. Because the CB understands that sometimes (half the time?) a bank faces outward dirham transfers before it receives inward dirham transfers then the commercial bank’s account with the CB will quite often go short, i.e. it has a negative dirham balance, the retail equivalent of an overdraft. This is equivalent to the commercial bank borrowing from the CB. The CB allows this in the short term for the good order of the money markets, but to avoid abuse it requires commercial banks to remain flat or long on their CB dirham accounts on a weekly basis.

What does this mean? Let us assume that the CB week is Sunday to Thursday. If bank A ends up transferring out net AED 100 million on Sunday then they will be short on their CB account AED 100 million. They need to make up for this. If there are no transactions on Monday then bank A is short AED 200 million, i.e. AED 100 million multiplied by two days. To go flat, i.e. make up for the short position, bank A has several options at this point. It can go long AED 200 million for one day, i.e. raise that amount in new deposits, or it can go long AED 100 million for two days, etc.

If the math is confusing then simply think of it this way: if deposits leave a bank then other deposits have to enter the bank to make up for it, adjusted for time.

Now that we have set the stage, let us introduce the actors. The star of this play is a money center bank that we will call Godzilla. A money center bank is a major bank that due to its government and blue chip client base is a major player in the dirham money markets. Next is NewCo, a company that was being IPO’d by Godzilla. NewCo was wildly popular and over 42.7 times subscribed (actual number changed to protect privacy but the order of magnitude is correct).

The tragedy of this play was that Godzilla exchanged billions of dirhams into dollars and moved these funds offshore, i.e. out of the UAE’s dirham money markets. Normally, a bank would exchange dirhams to dollars using the interbank market, i.e. they would trade with other banks giving them dirhams and receiving dollars. This is not what happened and instead Godzilla engineered what is known as a short squeeze. It is not public how Godzilla managed to bypass the interbank currency markets and acquire their dollars without injecting the billions of dirhams they had back into the money markets.

The result was chaos. Overnight dirham rates reportedly hit 14%. Godzilla’s excuse was that their client NewCo wanted an offshore dollar deposit. There is absolutely nothing wrong with that. What is unforgivable is Godzilla’s decision to bypass the interbank markets and suck out billions of dirham liquidity that badly affected the other banks.

Thankfully there were, and are, many government institutions monitoring the situation and a large, extremely large, institution stepped in to fill the gap the Godzilla created.

I was still a student when all of this happened. A short few years later I was the treasurer of a bank and Godzilla tried to short squeeze my team. My team rose to the occasion and spanked Godzilla hard (this is technical trading term). Stay tuned for the story of Godzilla Returns.