Large corporates with aggressive investment plans may find it tough to raise funds locally. The Reserve Bank of India’s decision not to allow credit derivatives will mean that banks which had touched their exposure limit to large corporate houses cannot continue funding. It was earlier expected that banks could continue funding large borrowers even after touching the exposure limit by eliminating credit risk through derivatives.
In a statement issued here on Thursday, RBI said, “It has been decided to keep in abeyance the issuance of the final guidelines on introduction of credit derivatives in India. The decision has been taken so as to be able to draw upon the experience of the financial sector of some of the developed countries, particularly in the current circumstances, in which the entire dimensions of the recent credit market crisis have not yet been gauged.”
Credit derivatives are complex financial instruments which are mainly privately-held non-negotiable contracts that allow users to manage their exposure to credit risk. They are generally financial assets like forward contracts, credit default swaps, and options. For example, a bank concerned that one of its customers may not be able to repay a huge loan can protect itself against the loss by transferring the credit risk to another party while keeping the loan on its books.
RBI had initially issued draft guidelines for the introduction of credit derivatives in India in March 2003.
Thereafter, a second draft of the guidelines was issued in May 2007. The draft guidelines had proposed a phased approach, with only the basic credit default swap being allowed in the first stage. Primary dealers would have been able to transact in a credit default swap, if the objective is to protect against the credit risk in a tradable bond. Banks also could transact in swaps, if the credit risk arose out of a bond or any credit exposure such as a loan.
Further, insurance companies and mutual funds would have been allowed to buy or sell protection only when the Securities and Exchange Board of India (Sebi) and Insurance Regulatory and Development Authority (IRDA) allowed them to do so.
However, the draft guidelines had also placed a number of restrictions. Primary among this is a requirement that all parties are required to be Indian and that deals take place in rupees. The other requirement is that protection would be provided only in respect of borrowers who are rated. Unlike some credit derivatives which can be structured to provide protection for a set of borrowers, RBI’s draft prescribes that CDS can be only in respect of a single borrower.
In a statement issued here on Thursday, RBI said, “It has been decided to keep in abeyance the issuance of the final guidelines on introduction of credit derivatives in India. The decision has been taken so as to be able to draw upon the experience of the financial sector of some of the developed countries, particularly in the current circumstances, in which the entire dimensions of the recent credit market crisis have not yet been gauged.”
Credit derivatives are complex financial instruments which are mainly privately-held non-negotiable contracts that allow users to manage their exposure to credit risk. They are generally financial assets like forward contracts, credit default swaps, and options. For example, a bank concerned that one of its customers may not be able to repay a huge loan can protect itself against the loss by transferring the credit risk to another party while keeping the loan on its books.
RBI had initially issued draft guidelines for the introduction of credit derivatives in India in March 2003.
Thereafter, a second draft of the guidelines was issued in May 2007. The draft guidelines had proposed a phased approach, with only the basic credit default swap being allowed in the first stage. Primary dealers would have been able to transact in a credit default swap, if the objective is to protect against the credit risk in a tradable bond. Banks also could transact in swaps, if the credit risk arose out of a bond or any credit exposure such as a loan.
Further, insurance companies and mutual funds would have been allowed to buy or sell protection only when the Securities and Exchange Board of India (Sebi) and Insurance Regulatory and Development Authority (IRDA) allowed them to do so.
However, the draft guidelines had also placed a number of restrictions. Primary among this is a requirement that all parties are required to be Indian and that deals take place in rupees. The other requirement is that protection would be provided only in respect of borrowers who are rated. Unlike some credit derivatives which can be structured to provide protection for a set of borrowers, RBI’s draft prescribes that CDS can be only in respect of a single borrower.
Source URL: http://economictimes.indiatimes.com/rssarticleshow/msid-3146874,prtpage-1.cms
Publish Date: June 20, 2008
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