Credit risks has always been a factor of concern for banks and financial institutions. Growing credit defauls is making credit derivatives as the best alternative to hedge these risks.No one has any doubts that credit risks have substantially increased in global banking over the last few years. One can take a macro global vision, or limit oneself to India: the results are the same but the reasons may be different.

In global sense, increased credit risks arise due to two reasons: one, banks have been forced to lend to riskier clients because well rated corporates have moved away from banks to access capital markets directly. This is clearly proved by statistics over last 25 years or so. The vast array of capital market products have brought corporates to Wall Street rather than resort to traditional banking relationships. Banks balance sheets have more of below investment grade bonds, syndicated loans and commercial real estate lending today than in the past.

The other contemporary reason is the lurking fear of recession, now almost confirmed by most economists. Inspite of very low rates of interest, the US economy is showing increasing unemployment rate and increasing losses on consumer credit. The bankruptcy index has shot up as well.

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