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In order to answer that question we must briefly look back. One reason why financial derivatives are so problematic is that they have developed so fast in such a short period of time. Before the 1970s, the landscape was entirely different: most bankers and finance professionals had never heard about derivatives, and business schools only mentioned them in the context of agriculture. Then with the revolution of information technology, coupled with financial deregulation, an increasing number of financial innovations were conceived and placed on the market. Through the 1980s and 1990s, increasingly complex derivatives, such as interest rate swaps and mortgage-backed securities were introduced. In the early 2000s came credit derivatives, which are at the heart of the present crisis.
In India, things have changed even faster. Until the 1990s, the Indian Government practiced very restrictive principles in financial markets. Then quite suddenly, stock markets began to be developed and rules were systematically liberalized. In 1999, some exchange-traded derivatives were permitted under the amended Securities Contract Regulation Act. Exchange-traded derivatives have not proved particularly problematic, perhaps because the rules imposed by the Securities Exchange Board of India (Sebi) have been quite strict. However, a much more important sector—both in India and globally—is the market for Over-the-Counter (OTC) derivatives. These are increasingly complex derivatives contracts made between banks and businesses, investment funds, insurance funds, etc., often without any regulation or control. |
