RBI set to introduce credit default swaps

The Reserve bank of India (RBI) on Wednesday proposed to
introduce credit default swaps, or CDS, in Indian markets, enabling
firms to hedge against any possible default by a bond issuer.

CDS is a derivative used to offset risks in debt markets. It allows
creditors to insure themselves against the possibility that a borrower
might default.

The draft guidelines were put up on RBI’s website late Wednesday. It
did not say when the instrument would come in play but invited public
comments to the report—titled “Draft Report of the Internal Group on
Introduction of Credit Default Swaps for Corporate Bonds”—till 4
October.

This is the third time RBI has come out with a draft report on CDS. The
first was in 2003 and second in 2007.

The introduction of CDS got stalled after a credit crunch hit the
global financial system in the wake of the collapse of US investment
bank Lehman Brothers Holdings Inc. in 2008.

CDS was blamed for the crisis and the near collapse of largest
insurance firm in the world, American International Group Inc.
Investors were trading CDS as stand-alone instruments and the trade
proliferated exponentially.

RBI has already introduced instruments such as repo, or repurchase, in
corporate bonds or interest rate futures, but CDS is possibly the most
sophisticated financial instrument the Indian market could be seeing.

Like all derivatives that reflect the value of an underlying
instrument, CDS reflects the value of a bond or a loan. If an investor
in a company’s bond wants to buy an insurance against a possible
default by the issuer, the investor could buy CDS for a price,
technically called CDS spread. The CDS seller, in turn, guarantees to
pay the buyer a predetermined amount if the bond issuer defaults on
repayment.

To avoid inherent risks, the draft report on CDS says users cannot
purchase CDS without having an underlying exposure and the protection
can be bought only to the extent (both in terms of quantum and tenure)
of such underlying risk.

“Since the users are envisaged to use the CDS only for hedging their
credit risks, the group recommended that the users shall not, at any
point of time, maintain naked CDS protection,” the draft report said.

This means CDS cannot be used as a pure trading instrument. “This
instrument ensures that banks take position on companies from an arms
length even when not directly lending to them. After some time, it
could be possible that international CDS of Indian companies could be
brought back to India for trading,” said a banker who did not want to
be identified.

To restrict users from holding naked CDS positions—CDS bought without
underlying exposure—physical delivery is mandated in case of credit
events, the report said, adding users are prohibited from selling CDS.
It also proposed “rigorous audit” to ensure that buyers of CDS have
underlying exposure, and to make “physical settlement” mandatory for
CDS buyers.

Market-makers of these instruments, which include commercial banks,
primary dealers and non-banking financial companies (NBFCs), insurance
companies and mutual funds, have other options to settle their
positions.

Users category would consist of commercial banks, primary dealers,
NBFCs, mutual funds, insurance companies, housing finance companies,
provident funds and listed corporations.

“All CDS trades shall have a RBI-regulated entity at least on one
side,” the draft said.

At the initial stage, related parties or banks and their subsidiaries
cannot enter into CDS transactions between themselves, since “it would
be difficult to have an objective and transparent price discovery
mechanism at the initial stages and, therefore, it would be difficult
to determine whether an ‘arms’ length relationship exists or not”.
Market-makers should have sound financial fundamentals, the report
said.

Market-makers cannot enter into CDS transactions without obtaining from
the counterparty a copy of a resolution passed by their boards
authorising it to transact in CDS.

RBI said a centralized CDS repository with reporting platform could be
set up for transactions in CDS and it may be made mandatory for all CDS
market-makers to report their trades on the platform within 30 minutes
from the deal time. A separate reporting platform for CDS transactions
would be developed and housed along with the reporting platform for
over the counter derivatives.

In the interim, clearing houses such as Clearing Corporation of India
Ltd can be given the responsibility on a non-guaranteed basis, it said

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Dhanalakshmi Bank in Talks With Partners to Set Up Asset Management Unit

Dhanalakshmi Bank Ltd., an Indian lender, is in talks with potential
partners to set up an asset management unit as it expands its fee-based
income business.

The bank, based in the southern state of Kerala, will own 20 percent of
the money manager, Managing Director Amitabh Chaturvedi said in an
interview in Mumbai today. The dominant partner will control 51
percent, while a third company will own 29 percent, Chaturvedi said
without identifying the companies. Dhanalakshmi expects to start the
venture by December, he said.

“Our preferred route will be to hold major management control with a
minority stake and discussions are in process,” Chaturvedi said. “The
optimism is coming from the opportunities we are anticipating in this
segment.”

Rising income levels in the world’s third-fastest growing major economy
are prompting companies including Dhanalakshmi, meaning goddess of
wealth in Sanskrit, to tap emerging opportunities. Indians may see a
10-fold increase in their incomes by 2025, according to a study by
McKinsey Co.

Dhanalakshmi gained 1.5 percent to 192.75 rupees in Mumbai. The stock
has advanced 32 percent this year while the benchmark Bombay Stock
Exchange’s Sensitive Index has risen 4.3 percent.

India’s mutual funds industry grew more than fivefold in as many years,
with assets under management increasing to 8.05 trillion rupees in May,
according to data compiled by Bloomberg. India’s 1.1 billion people,
almost half of whom are under 25 years old, are spending more on
electronics, clothes and cars.

Economic Recovery

Dhanalakshmi Bank in July raised funds from 42 select institutional
investors, including the local units of JPMorgan Chase Co. and HSBC
Plc to boost capital.

The lender aims to increase consumer lending to as much as 90 billion
rupees ($1.9 billion) by March from 50 billion rupees a year earlier,
Chaturvedi said.

“We won’t need to raise any further capital in this financial year
after the completion of the placement,” Chaturvedi said.

Bank lending in India, Asia’s third-largest economy, to companies and
individuals grew more than 21 percent in the year through July, the
fastest pace since January 2008, signaling rising demand. Reserve Bank
of India Governor Duvvuri Subbarao on July 27 said India’s economic
recovery is “firmly in place and strengthening.”

Dhanalakshmi plans to increase loans for vehicles and homes fivefold to
30 billion rupees, Chaturvedi said, as more Indians borrow to purchase
motorcycles and cars.

Tata Motors Ltd., an Indian car and truck maker, reported sales in July
climbed 41 percent, while motorcycle maker TVS Motor Co. said on Aug. 1
its sales grew 35 percent last month.

The central bank last week raised India’s growth forecast to 8.5
percent from 8 percent for the year ending March 31.

Regards
Anoop Agrawal aagrawal8@bloomberg.net.

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Banks not following RBI norms for opening no-frill accounts: FM

Government today admitted that certain banks were not
following guidelines on opening no frill, zero balance accounts in
rural areas and said efforts were being made to make banking facilities
available to remotest part of the country through various means.

Finance Minister Pranab Mukherjee said in Lok Sabha that certain banks
might not be observing guidelines of the Reserve Bank of India in
opening no-frill, zero balance accounts in rural areas.

Mukherjee said he has asked banks to listen to the political leadership
and the state governments in addressing the grievances of the people.

He was answering a supplementary question by Arjun Singh Meghwal (BJP)
on complaints that banks were denying zero balance facility to people
in rural areas.

His views were supported by several members across political parties.

He said the Chief Ministers have been requested to take meetings of
state level bankers. Similarly, officers have been directed to meet
bank officials at the district level so that the role of the middleman
is eliminated.

Stressing the need for a "vigilant mechanism", he said branch officers
were being made accountable.

Replying to another question, Minister of State for Finance Namo Narain
Meena ruled out special incentives to bank officials for deployment in
rural areas. "It is part of their normal work," he said.

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Six mths on, headless PSBs still wait for appointment

Many public sector banks are currently lying headless as the
government is yet to issue appointment letters even though selection
process is completed for these posts. Banks like Canara Bank,
Corporation Bank, UCO Bank and Punjab Sindh Bank are waiting for the
new CMDs to join as the government is yet to issue appointment letters.

The selection procedure for the bank chiefs was brought under scanner
by a few members of the parliament earlier this year. Questions were
raised regarding transparency of the selection process and allegations
were filed by a few MPs regarding ad hoc selection of the bank chiefs.

According to sources, although the process to select chiefs of 10 PSBs
had started six months back, the Cabinet secretary is yet to clear the
names for the approval of the appointment committee of Cabinet (ACC).
After getting cleared by the ACC, the file containing the proposed
names will reach Prime Minister’s office for the final clearance.
Earlier the ministry of finance had chosen S Raman, executive director,
Canara Bank as the CMD of Canara Bank , while RN Pradeep and Arun Kaul,
both of them EDs of Central Bank, have been selected for the
Corporation Bank and UCO Bank, respectively.

JM Garg, who retired as the CMD of Corporation Bank, has been appointed
as the chairman of SUUTI.

The post of Andhra Bank’s CMD will also fall vacant at the end of this
month as the present incumbent RS Reddy will complete his tenure as the
chief of the bank and R Ramachandran, ED of Indian Bank has already
been named as the new CMD of the Hyderabad-based bank. Two other posts-
CMDs of Bank of Maharashtra and Indian Overseas Bank— will also fall
vacant in a couple of months. The selection process for AS
Bhattacharya, ED of Indian Bank, and M Narendra, ED of Bank of India,
has already been complete, sources said.

Certain other bank chiefs like Allen CA Pareira of Bank of Maharashtra
is due for retirement on September 30, SA Bhatt of Indian Overseas Bank
on October 31, TY Prabhu of Oriental Bank of Commerce on December 31.

Meanwhile, State Bank of India will also see top level reshuffle soon
as one of its managing director SK Bhattacharya is due for retirement
in October this year.

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ICICI, HDFC Bank flouted recovery norms: FM

The government today said at least two private banks — ICICI Bank and
HDFC Bank — had repeatedly violated the guidelines of the Reserve Bank
of India (RBI) on engagement of recovery agents.

In response to a question in the Lok Sabha, Finance Minister Pranab
Mukherjee said 120 complaints had been received by the banking
ombudsman regarding violation of the norms during 2009-10.

He, however, did not say what action was being contemplated by the
government and only listed the action initiated by RBI, the Banking
Codes and Standards Board of India and the Banking Ombudsman Scheme,
which was amended in February 2009. The amendments allowed the
ombudsman to award a compensation of up to Rs 1 lakh in case of
complaints arising out of credit card operations of banks.
Besides, Mukherjee said banks had been asked to undertake period review
of the recovery mechanism and improve upon them. RBI had issued
detailed guidelines to banks on engagement and training of recovery
agents. Banks had been advised to ensure the recovery agents were
properly trained to handle cases with care and sensitivity,
particularly with respect to hours of calling, privacy of customer
information, etc.

Banks had been advised to ensure that the contracts with the recovery
agents did not induce adoption of uncivilised, unlawful and
questionable behaviour of recovery process, he said.

The finance minister also said the banks, as principals, being
responsible for actions of their agents, had been advised to ensure
that the agents engaged for recovery of the dues strictly adhere to the
guidelines and instructions issued by RBI, including the Banking Codes
and Standards Board of India.

RBI and the government were forced to act after banks were accused of
resorting to unfair means, including the use of musclemen, to recover
dues related to outstanding credit card bills and personal loans.

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