Credit derivatives are one of the latest innovations in the financial markets that have of late gained enough importance and relevance. This article speaks about the use of such credit derivatives products in the banking industry. Primarily, it explains the various types of credit derivatives products, the complex nature of such products and the ways by which banks can control and manage their risks by using such products.
Throughout the world, the banking sector has faced a number of financial crises. In India too, banks are reeling under the weight of huge Non-Performing Assets (NPAs). A banking crisis happens when the NPAs of a bank cross 10% of the assets in the balance sheet or when there is an extensive banking failure, as in the case of the cooperative banking sector in Gujarat and Andhra Pradesh.
the apex bank of the country has to intervene with measures such as deposit freeze, deposit guarantee schemes for rehabilitation or merger of loss-making banks, etc. Severe banking crises lead to run on banks, substantial shifts in their portfolios, collapse of the financial sector of the country and massive government intervention to prevent further banking failure.
A single bank can be said to have economic insolvency when the market value of its assets is lower than the value of its non-equity liabilities, or when the value of its net worth in the books of accounts is negative. When such a situation occurs, the bank fails to meet its obligations to the depositors and then measures have to be taken to liquidate it or restructure it. The most common causes of insolvency are large losses, frauds, intentional defaults of borrowers, weak economic environment, adverse currency fluctuations, maturity mismatches in the Asset Liability Management (ALM), misappropriation of funds, etc. |
