Previous

Page - 5

Major Factors Responsible for the Growth of Financial Derivatives

• Integration of international markets with national financial markets

• Increased volatility in asset prices in financial markets

• Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies

• Improvement in technology and communication facilities and sharp decline in costs

• Innovations in the derivatives markets have led to the diversification of risk over a large number of financial assets, leading to higher returns

• The modernization of commercial and investment banking

• Sectors of underdeveloped economies, such as commercial banking, which had been closed to foreigners, have been opened to foreign private sector investment

• Restructuring of the corporate sector

• Increase in the number of stock markets

• The privatization of state-owned enterprises

Areas of Concern

• The major area of concern is the manner in which the derivatives market can expand the risk taking activity. By enhancing the efficiency of transactions and capital, derivatives can increase both hedging and speculation.

• Derivatives might also lead to unfair practices like fraud, manipulation, outflanking prudential financial market regulations, manipulate accounting rules and evade taxation.

• Most of the OTC derivatives are non transparent in nature. This increases the risk in this market and further enhances speculation.

• Worldwide there has been introduction of a new credit risk, which seeks to shift the various types of risks. This new credit risk, especially in OTC markets, is not subject to collateral or margin standards or requirements and is not treated in the most economically efficient way for purposes of capital requirements.

• The liquidity risks attached with the interest rate swaps are another area of concern.

Next

* Contributed by -
Nishant Bachkheti & Aarti Nagarajan,
Core Committee Members, Fin-Niche,
IMT, Ghaziabad.