“IS INDIA READY FOR CREDIT DEFAULT SWAPS

Topics: Credit default swap, Credit risk, Credit derivative Pages: 13 (2862 words) Published: March 3, 2014

“IS INDIA READY FOR CREDIT DEFAULT SWAPS?”

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Index

1. Executive Summary

1

2. Introduction

2

3. Positive Implications of the Introduction of CDS

4

4. Negative Implications of the Introduction of CDS

6

5. Issues Demanding Urgent Attention

8

6. Conclusion

10

7. Bibliography

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Is India ready for credit default swaps?

1
Executive Summary
“…..bankers are in the business of managing risk, pure and simple, that is the business of banking.”
- Walter Wriston,
Former CEO, Citibank
With India having grown at an average of 8.6% in the past 4 years, there has been an excessive demand for capital from all sorts of businesses to further fuel their growth. Banks seek to address this need for capital and in turn assume risk. But for India to continue to grow at over 9% it’s an imperative that we have healthy financial institutions which are able to manage their risks well. Credit derivatives which emerged globally nearly a decade ago and created a rage as effective tools for credit risk management are set to make their debut in India to help banks better manage their credit risks.

This paper seeks to address the immense relevance of credit derivatives, particularly CDS, in the Indian context. The introduction shall provide an overview of the significant features of the recent guidelines on the introduction of CDS. The author is rather optimistic in his view of the future course of development of the Indian credit derivatives market. In keeping with this view, the paper highlights the positive/negative implications of the introduction of CDS and the issues that may emerge as the market gains scale. The paper shall also endeavor to identify issues which demand urgent attention of the regulators to ensure the healthy growth of credit derivatives in India.

Is India ready for credit default swaps?

2
Introduction
“ISDA Mid-Year 2007 Market Survey: Credit Derivatives at $45.46 Trillion” - Notional amount outstanding of credit derivatives grew by 32% in the first 6 months of the year to $45.46 trillion from $34.42 trillion.

- The annual growth rate for credit derivatives is 75% from $26.0 trillion at midyear 2006. Source: ISDA

“Credit-default swaps linked to loans will be more actively traded in the U.S. than the loans themselves within a year…..”
Source:Citigroup Inc.

“………several Indian names are traded on a regular basis in global credit derivatives markets and two Indian names are a part of a popular traded credit derivative called iTraxx Asia ex-Japan.”
Source: www.vinodkothari.com

The above illustrations are reflective of the tremendous popularity that credit derivatives have attained in the globally. They’re also indicative of a lackadaisical response on part of the Indian regulators towards the introduction of credit derivatives which has led to the domestic credit derivatives market being exported to offshore subsidiaries of Indian banks.

The RBI recently released the “Draft Guidelines on Credit Default Swaps”, as a small first step towards creating an onshore credit derivatives market. The guidelines aim to introduce CDS in a calibrated manner in India and are reflective of a conservative approach adopted by the RBI. The conservatism possibly stems from the inexperience of the Indian markets with such products, but could in-part also be attributed to derivatives being viewed as “financial weapons of mass destruction”. The role credit derivatives had to play in the recent Sub-prime crisis does to an extent validate the adopted approach.

The guidelines regulate credit derivative transactions by Indian resident commercial banks & primary dealers. Currently only 'plain vanilla' credit default swaps (CDS) have been permitted. The guidelines limit CDS trades to transactions referenced to single,

Is India ready for credit default swaps?

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rated, resident entities only, with both the protection buyers (PB) and protection sellers (PS) being resident....

Bibliography: 11. Ministry of Finance – Department of Economic Affairs (December 2005).
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