A Credit Default Swap (CDS) is like insurance for lenders. It is a financial derivative that allows a lender to swap or transfer the risk of a borrower defaulting on a loan. The lender pays a fee to another party, the CDS protection seller, who agrees to cover the defaulted amount if the borrower fails to meet the loan obligations.
How do CDS work in India according to the Master Directions by RBI?
In India, the Reserve Bank of India (RBI) issued the Master Directions on Credit Derivatives in 2022. These directions apply to derivative contracts derived from the credit risk of underlying debt instruments traded over-the-counter (OTC) or on recognized exchanges. Key players in the CDS market include banks, non-banking financial companies (NBFCs), insurance companies, and mutual funds, among others.
Who can participate in the CDS market in India?
Participants in the Indian CDS market include both resident and non-resident entities like foreign portfolio investors, non-resident Indians, and overseas citizens of India. Eligible participants also include financial institutions such as scheduled commercial banks, certain NBFCs, and entities like the Export Import Bank of India and National Bank for Agriculture and Rural Development.
What are the regulatory controls on CDS in India?
The RBI’s Master Directions provide a comprehensive regulatory framework for CDS to promote transparency and prevent market manipulation. These include eligibility criteria for market participants, standardization of contract terms, and strict reporting requirements. The directions aim to prevent the misuse of CDS, which had been linked to financial crises in the past.
These FAQs provide a basic understanding of Credit Default Swaps in India, focusing on their regulatory aspects and market dynamics as per the latest guidelines from the RBI.
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