RBI opens Credit Default Swap
RBI has released a framework of Credit Default Swap in Indian market. This time norms are open for FII(Foreign Institutional Investors ) also.
RBI has announced that they will introduce CDS into market from 27 October. They have defined the framework of CDS for India. CDS may help FIIs and MFs to hedge the underlying assets. This allows banks to keep exposure over specific client. First time, RBI has included FIIs into CDS plan.
Current Framework of CDS as defined by RBI include two types of users:
1.Market Makers: Banks, NBFCs, primary dealers are permitted to buy CDS
2.Users: banks, MFs, insurance, Provident funds, housing finance funds, companies and FIIs.
|The Framework for CDS in India|
|Commercial banks, PDs, NBFCs,
mutual funds, insurance companies,
housing finance companies, provident
funds, listed corporates, FIIs
|Can buy and sell CDS||Cannot sell protection and hold short
|Can buy protection
without having the
|Cannot buy protection for amounts or
tenor higher than that of the
|Can opt for any of the
cash and auction)
CDS was blamed for financial crisis, due to which largest insurance firm America International Group Inc. and investment bank Lehman Brothers Holdings Inc. collapsed.
What is CDS?
1. CDS is a risk management product that helps entities against possibility of default risk. Entities include FIIs, banks, insurer, NBFCs, listed companies housing finance companies, provident funds and primary dealers.
2. Credit default swaps are insurance-like contracts that promise to cover losses on certain securities in the event of a default. They typically apply to municipal bonds, corporate debt and mortgage securities and are sold by banks, hedge funds and others. The buyer of the credit default insurance pays premiums over a period of time in return for peace of mind, knowing that losses will be covered if a default happens. It’s supposed to work similarly to someone taking out home insurance to protect against losses from fire and theft.
Except that it doesn’t. Banks and insurance companies are regulated; the credit swaps market is not. As a result, contracts can be traded — or swapped — from investor to investor without anyone overseeing the trades to ensure the buyer has the resources to cover the losses if the security defaults. The instruments can be bought and sold from both ends — the insured and the insurer.
I am trying to understand CDS.. If anyone could explain ideas are most welcomed.. 🙂