No credit derivatives for India: global financial centre a distant dream

One drawback of the Indian corporate bond market is the absence of credit derivatives. Regulatory reluctance was a main reason for this phenomenon. This had changed over the years with strong lobbying from all interested parties and the government giving a go-ahead from its side. The government had made announcements to that effect in the 2006-07 Budget and even commissioned a report on making Mumbai a regional financial centre.

An active credit derivatives market is one of the prerequisites for a successful international financial centre. In fact, the RBI had moved towards allowing the launch of credit default swaps. But the RBI today put out a brief note effectively snuffing out hopes of an credit derivatives. The sub-prime crisis in the West, particularly the role of exotic credit derivatives in it, has made the central bank wary. This is a big blow to the integration of Indian capital markets with global markets. In particular, all hopes of India becoming an international financial centre have gone up in smoke.

The RBI announcement does not talk about how long before they will reconsider this decision. It only says that they want to assess the impact of the sub-prime crisis and the role of credit derivatives in developed countries. That could take as long as some years as the sub-prime crisis is yet to completely unravel.

Here is the text of the RBI announcement:“It has been decided to keep in abeyance the issuance of the final guidelines on introduction of credit derivatives in India. The decision has been taken so as to be able to draw upon the experience of the financial sector of some of the developed countries, particularly in the current circumstances, in which the entire dimensions of the recent credit market crisis have not yet been gauged. It may be recalled that the Reserve Bank of India had issued the ‘Draft Guidelines for Introduction of Credit Derivatives in India’, on March 26, 2003, inviting comments from banks and other stake holders. However, taking into account the status of the risk management practices then prevailing in the banking system, the issuance of final guidelines had been deferred. Subsequently, it was announced in the Annual Policy Statement for 2007-08 (paragraph 175) that as a part of the gradual process of financial sector lilberalisation in India, it was considered appropriate to introduce credit derivatives in a calibrated manner. Modified draft guidelines on Credit Default Swaps were, therefore, issued on May 16, 2007.

Based on the feedback received on draft guidelines, these were revised and a second draft of the guidelines was issued, on October 17, 2007, for another round of consultation. However, in view of certain adverse developments witnessed in different international financial markets, particularly the credit markets, resulting in considerable volatility in the recent past, such as mounting losses suffered by banks on account of sub-prime crisis, need for the central banks of those countries to inject liquidity into the system, as also the level of risk management systems and possible non-adherence to the regulatory guidelines on complex products such as credit derivatives, time is not considered opportune to introduce the credit derivatives in India, for the present."

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