JOIN USNorms for credit default swap soon
“The Reserve Bank will shortly come out with the guidelines for introduction of credit default swaps market, which can help develop the corporate debt market in some ways,” Gokarn told reporters here at the sidelines of a seminar.
CDS is a specific kind of counterparty agreement that allows transfer of third-party credit risk from one party to the other.
Under a CDS agreement, a lender facing credit risk from a third party, can transfer his risk to a counter party who agrees to insure the risk in exchange of regular periodic payments, essentially an insurance premium. If the third-party defaults, the insurer will have to purchase the defaulted asset from the insured party and the insurer in turn will have to pay the remaining interest on the debt and the principal to the insured.
Towards developing a corporate bond market, RBI has already allowed new products like interest rate futures, currency futures and repo in corporate bonds, besides raising FII cap on corporate bond exposure, and many other reforms like unified market conventions, reporting platform for OTC interest rate derivatives among others. It has been argued that if banks are permitted to guarantee corporate bonds, market may attract more interest. As of now there is hardly any private bond market in the country, as it is almost fully (95 per cent) dominated by government securities/bonds market.
However, it is also felt that if banks are allowed to enter the CDS space, it will hinder development of genuine corporate bond market and result in risk concentration within the banking system, which is not the purpose of market-based dis-intermediation process. Last week, RBI executive director Deepak Mohanty had opined that for corporate bond market to develop, the government should bring down its huge borrowing programme.
“If the government reduces its borrowing programme, fiscal consolidation happens, and then there is demand for corporate bonds,” he said and added that unless reforms in pension and insurance sectors take place corporate bond market cannot develop well.