So, modern finance is un-Indian?

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: In commentary on the current crisis, villainous roles have been assigned to collateralised debt obligations (CDOs). There is nothing wrong with the basic principle or mechanism of CDOs or asset-backed securitisation and the sale of repackaged debt stocks. They are useful for transforming maturities/durations and liquefying assets. Used properly, the risks of firm-level, and systemic, illiquidity can be substantially reduced by CDOs and ABSOs. The same is true of much-maligned derivatives both simple/traded and complex/tailored. Yet both are now condemned (especially in India) as inherently flawed; in particular, derivatives. This mindless vilification is reaching insane proportions in India with the losses recently suffered on currency hedges. Indian corporates who made the wrong bets on currency hedges have incurred collective losses alleged to be Rs 200 billion (or $5 billion). They are now crying foul and blaming their bankers for tailoring these hedges to their specified needs. They are pleading ignorance and lack of understanding of what was involved and what the risks were. So everyone is blaming derivatives when they should be focusing on unsound judgements across the board.

The RBI is joining in the chorus. Is it blameless for not having permitted a market to develop in exchange traded currency derivatives in the first place? Had such a market developed, corporates could have traded on it and not gone to their banks. Talk of these instruments being inherently deadly and dangerous is plain wrong. Yet, the retroactive ‘modern finance-is-wrong-RBI-is right’ strain of virus is infecting many. It is being propagated by the Indian media and a Left uncomfortable with capitalism. Such criticism is often motivated by: wrong interpretation of the evidence; ignorance; and a failure (or unwillingness to make the effort) to understand what is involved. Since no one (especially a central banker) wants to admit to being ignorant, or slow on the uptake, it’s easier to cast aspersions and make the case that these instruments are too dangerous for public use. Yet, derivatives and synthetics are indispensable in a modern financial system. They are its traffic signals, its price discovery mechanisms, as well as its trading nuts and bolts; grist for the financial mill that would otherwise be confined to only four plain vanilla functions (buy, sell, borrow, lend). If that was all finance could offer we would be back in pre-historic times.