Mumbai: The Reserve Bank of India (RBI) on Thursday put on hold its plan to allow commercial banks to sell credit derivatives in the country, saying it is not the right time for it.
According to RBI, lenders across the world have suffered losses in the subprime mortgage crisis that has rocked the financial world, forcing central banks to inject liquidity into the system.
This has happened on account of “possible non-adherence to the regulatory guidelines on complex products such as credit derivatives” and hence the time is not “opportune to introduce the credit derivatives in India, for the present,” an RBI release said.
A credit derivative is a contract between two parties that allows for the use of a derivative instrument to transfer credit risk from one party to another. The party transferring risk away has to pay a fee to the party that will take the risk. This over-the-counter product allows institutions to manage credit risks more effectively.
Bankers declined to comment on the RBI move but risk mangement experts and banking consultants said the regulator is on the right path.
“In the current circumstances, it would have been imprudent for RBI to introduce credit derivatives,” said A.V. Rajwade, an independent risk management expert. “The global credit crisis was on account of use of complex derivative structures. We have also seen the impact of the use of forex derivatives in the domestic markets.”
Ashvin Parekh, partner at financial services firm Ernst and Young Pvt. Ltd, said there is a need to create a conducive market for these complex products but “at a time when managing inflation and growth are top priorities, creating more complexities in the market by introduction of new instruments can make things difficult for the regulator”.
ICICI Bank Ltd, India’s largest private sector lender that runs a global business of about $25 billion (Rs1.07 trillion), has close to $2.2 billion exposure to credit derivatives. It had made a mark-to-market loss of $264 million in the fiscal to March on account of such intruments as well as an erosion in the value of similar investments made by subsidiaries in the UK and Canada.
Mark-to-market is an accounting practice of assigning a value to a position held in a financial instrument, based on current market price and not at the price at which it was bought.
The banking regulator had issued draft guidelines for introduction of credit derivatives in India on 26 March 2003, and invited comments from banks. But taking into account the status of the risk management practices prevailing in the banking system, RBI had deferred issuing final guidelines.
Later, in its annual monetary policy statement for 2007-08, RBI had indicated that as a part of liberalizing the financial sector in India, it might introduce credit derivatives in a calibrated manner.
The regulator had issued a draft of guidelines on credit default swaps on 16 May 2007. Based on the feedback it received, it had issued a revised draft on 17 October 2007 for another round of consultation.
The story so far
SBI to offer lifeline to clients 3 May
Derivatives losses keep adding up 29 April
Why Indian firms’ love affair with derivatives soured 16 April
Foreign banks may have gained from derivatives sale 2 April
RBI may be made party to cases 24 March
Stung firms want banks to pay 17 March
Rs128 trillion derivatives on banks’ books 12 March
Read all these stories at www.livemint.com/derivativesnorms.htm