New financial tools require caution says RBI

New financial tools require caution says RBI

Mumbai, 21 September New financial tools like those at the root of the global credit crunch make a positive contribution to financial systems, but they need to be handled with caution to ensure stability, the Reserve Bank of India said on Thursday.

Deputy Governor Rakesh Mohan said despite all the problems associated with subprime borrowers in the US, market innovation had helped in bringing credit to those who needed it but had not had access to it earlier.

“From our point of view, we need to recognise the positive contributions that financial innovations make to enhance the efficiency of financial intermediation," Mohan told an economic forum.

But regulators also had to take account of the prevailing standards of governance and risk management systems, and he said the Indian central bank’s cautious approach had contributed to financial system stability and momentum of economic growth.

India does not have a domestic structured-credit market but it is examining introduction of rupee credit default swaps, which provide a hedge against default on debt.

Mohan said the subprime crisis was likely to make investors who had relied on credit ratings for structured credit products question the value of ratings in other markets.

Leveraged buy-out activity was likely to wind down and carry trades, where investors borrow in a low-interest currency to fund a position in another higher-yielding one, may moderate and even unwind abruptly, which would help maintain global financial stability, he said.

Rupee is a relatively high-yielding currency which has been on the end of carry trades.

At the moment, it was expected the fallout on Asian banks from the subprime crisis would be limited, Mohan said, but reiterated that if credit conditions tightened, emerging market economies could be vulnerable to an outflow of capital.

Regulators needed to recognise changes in the landscape of financial markets, such as in products, banking consolidation, increased electronic data flow and higher volumes and volatility.

“The key issue for central banks is to differentiate between providing short-term liquidity and operating medium-term monetary policy and communicate the difference credibly," he said. Reuters