The Reserve Bank of India (RBI) has proposed rules that would for the first time allow local banks and primary dealers to trade in credit default swaps, the fastest-growing derivatives market on credit quality.
“As part of the gradual process of financial sector liberalization in India, it is considered appropriate to introduce credit derivatives in a calibrated manner,” the central bank said on its website on Wednesday. “In view of complexities involved, the Reserve Bank has decided to initially allow only plain-vanilla credit default swaps.”
The central bank, which has acknowledged the need to deepen and broaden the debt market in India, is taking steps to introduce derivative instruments that would help investors hedge risks.
It now allows trading in credit derivatives such as asset-backed securities and mortgage-backed securities, or bonds backed by automobile and home loans.
“We may see a full-fledged market in six months of the final rules, and that will deepen our credit and bond markets,” said Parthasarathi Mukherjee, treasurer at UTI Bank Ltd in Mumbai. “We need to understand fully how far we can go.”
Credit default swaps are used to trade on the ability of companies to repay debt. Such contracts, tied to rupee-denominated debt, help banks manage risks better and is “critical” for the long-term financial health of lenders, the central bank said.
The global market for credit derivatives, conceived about a decade ago to help bondholders hedge against the risk of default, more than doubled in size for the third straight year in 2006 to cover $34.5 trillion (Rs1,415 lakh crore) of securities, according to a survey published last month by the International Swaps & Derivatives Association.
Trading in credit-default swaps is surging because they are cheaper and easier to trade than bonds. The contracts are the fastest-growing part of the $370 trillion market for derivatives, financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.
Investors may share their views with RBI on the proposed rules, which now apply only to resident single borrowers, and resident buyers and sellers of protection, the central bank said.
Oliver Biggadike in Tokyo contributed to this story.