Mumbai: The Reserve Bank on Thursday allowed Credit Default Swap (CDS), a derivative instrument that offers credit protection, for financial institutions and companies. The Reserve Bank of India (RBI), having considered that it is necessary in public interest and to regulate the financial system to its advantage, has issued notification specifying Credit Default Swap as a derivative, the central bank said in a statement. The CDS is a guarantee in which the buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap. The notification comes at a time when the bad loans problem in the banking system appears to be gradually building up. For instance, gross NPA of the country's largest lender reached a three-year high of 3.52 per cent of loans for the quarter ended June 30. The users of CDS include commercial banks, primary dealers (PDs), non-banking finance companies (NBFCs), mutual funds (MFs), insurance companies, housing finance companies, provident funds, listed corporates, foreign institutional investors and any other institution specifically permitted by the RBI. The RBI had announced in the second quarter review of monetary policy in October 2009 to introduce plain overt-the-counter single name CDS for resident entities. Following this, it had appointed an internal working group to finalise the operational framework in consultation with the market participants. The final report of the working group was presented to the RBI in February following which it sought public comments. As part of its measures to enable more financial markets reforms, the RBI also increased the period of short sale in government securities from the existing five days to a maximum of three months. In its guidelines on CDS issued in May for corporate bonds, the RBI said a credit event (that is, default on a previously agreed financial obligation) will cover restructuring, approved under the Board for Industrial and Financial Reconstruction, the corporate debt restructuring mechanism and corporate bond restructuring. The RBI observed that the objective of introducing CDS on corporate bonds is to provide market participants a tool to transfer and manage credit risk in an effective manner through redistribution of risk. "Since CDS have benefits like enhancing investment and borrowing opportunities and reducing transaction costs while allowing risk-transfers, such products would increase investors' interest in corporate bonds and would be beneficial to the development of the corporate bond market in India," the central bank had said. Read more at: http://profit.ndtv.com/news/show/rbi-allows-credit-default-swap-184038?cp