The Reserve Bank of India (RBI) has relaxed the eligibility norms for using credit default swaps (CDS) on corporate bonds. The move is aimed at ensuring wider participation from banks. The capital adequacy requirement for banks has been reduced from 12 per cent to 11 per cent and the requirement of core capital has been brought down from 8 per cent to 7 per cent.
CDS acts as an insurance for lenders in case a borrower defaults on a loan. The buyer of the cover against the loan makes regular premium payments to a counterparty, which assumes the risk in case of a default.
RBI on Tuesday released the final guidelines after accommodating various suggestions and recommendations from market players. The eligibility norms would be applicable from October 24, it said. Other than reducing the capital adequacy requirement, RBI also allowed restructuring under credit events for CDS, which were not included in the draft. The grace period was doubled to 10 business days from the sale of underlying bond to unwind the CDS position.
Even after these relaxation, market players feel these instruments will take a couple of years before they are actively used. “This is a good step towards developing the debt market in India, but with such strict conditions, the market will start off with small volume and a few players,” said Gopal Bhattacharya, MD & head global markets-India, Societe Generale. The regulator said ‘users’ could not exit the CDS by selling it off. They can exit either by unwinding the contract with the original counterparty or, in the event of selling the underlying bond, by assigning the CDS protection, to the purchaser of the underlying bond.
Non-banking finance companies (NBFCs) and primary dealers will require a minimum capital adequacy of 15 per cent. Banks and NBFCs that desire to use CDS should not have net non-performing assets above three per cent. Foreign institutional investors have been allowed only to buy credit protection to hedge their credit risk as users.
The CDS has been allowed only on listed corporate bonds and unlisted but rated bonds of infrastructure companies.
The corporate bond market in India is not fully developed as only top-rated bonds dominate the market at present. “CDS will encourage lower rated entities to enter the bond market as lenders will be able to hedge their risks,” said a treasury official with a public sector bank.