The Reserve Bank of India said on Wednesday complex structured products such as synthetic securitisation and credit derivatives will be permitted after studying the experience abroad and risk-management capabilities of the Indian system.
The regulator asked banks to maintain a high level of capital adequacy ratio to ensure that risks in the sector within manageable limits.
The central bank also said there was a need to enhance risk management and added that market participants and securities regulator would expand the information provided about securitised products and their underlying assets.
It also said the recent subprime crisis has shown the insufficiency of methodologies adopted by credit rating agency for structured products, given their multiple tranches and their susceptibility to rapid, multiple-notch downgrades.
Following the failure of rating agencies overseas, RBI said there is a need for these entities to clearly the ratings for structured products, improve their disclosure of rating methodologies and assess the quality of information provided by originators, arrangers and issuers of structured products.
It said the unfolding crisis has revealed the weaknesses of structured products and derivatives in the credit markets, including the 'originate-to distribute' model, which needs to be addressed.
While maintaining that derivatives as a product category are not new to India, RBI has in the past cited the experience with complex products in developed markets like the United States to keep in abeyance its decision to allow these products in India.
Though it has agreed to the launch of interest rate futures in early 2009, a decision on credit derivatives has been put on hold though two sets of draft guidelines have been issued.
The finance ministry is, however, keen that the products be launched and the experience in the US should not derail reforms.
Structured products are exotic derivatives like credit-linked notes or credit derivatives.
The credit-linked derivatives are instruments with the basic assets as loans or bonds.
If the value of an underlying loan or bond falls, banks make provisions in their asset books for the loss that may arise due to depreciation of the underlying loan
or bond.
In the report released On Wednesday, RBI said the banking sector in India does not have any direct exposure to the US subprime market.
However, some banks have indirect exposure through their overseas branches and subsidiaries to the US subprime markets in the form of structured products such as collateralised debt obligations and other investments.
However, such exposure is not very significant and banks have made adequate provisions to meet mark-to-market losses on such investments, the report said.