'CDS may add to woes of borrowers'

Mumbai, May 18: The RBI's bid to put in place credit default swaps (CDS) as a regulatory framework may benefit the banking sector as it would allow banks to eliminate risks by insuring loans or debt investments, but it is likley to add to the woes of the borrowers.

The Reserve Bank guidelines on CDS issued on Wednesday has opened up doors for commercial banks and primary dealers for transaction in single-entity CDS. Comments from stake holders on the provision have been sought.

CDS is a financial instrument that allows banks to hand over the risks of loans to a third party called protection seller, for which the banks should pay a periodic fee to the latter.

The protection seller can either be financial institutions or other banks and are supposed to refund the loan to banks in case the borrower fails to repay the amount.

''This will allow banks to transfer the risks of bad loans to a third party instead of incurring huge losses through write-offs,'' a senior manager with a public sector bank told sources on conditions of anonymity.

The Central bank had mooted the step as part of its efforts to impart gradual liberalization in the country's financial sector.

While chances of credit default will be taken into account by the protection sellers in deciding the premium, the highest risk associated with CDS is considered to be the inability of the protction seller in refunding the default loan.

On the other hand, the implementation of CDS may burden the borrowers since the banks are likley to pass on the premium amount to the borrower resulting in higher lending rates, said industry sources.

However, the burden of additional costs are expected to reach only a certain catagory of customers as the burden on the priority sector borrowers are likely to be absorbed by the banks themselvs.

UNI