The proposal to introduce credit default swaps in the Indian financial system is one of the most significant decisions taken in recent times.
Till now, banks had very basic tools to limit their credit risk to any sector or company. The availability of credit default swaps will now allow banks to manage their credit risks better, just as the availability of interest rate and foreign exchange derivatives helped them manage those types of risk.
RBI’s discussion note suggests that it is thinking of getting in other types of credit derivatives in the years ahead. This, too, needs to be welcomed, but with a note of caution.
Credit derivatives have taken off globally only in the past five years, and their ability to withstand shocks has not been tested because of a huge boom in the global economy. Banks will have to train their staff to use these instruments. And RBI needs to ensure a smooth settlement system and also keep an eye on the market.