Credit default swaps, a financial intrument which insures creditors against default on loans owed by them is likely to be introduced next year. A credit default swap (CDS) is essentially a financial instrument that allows a bank or a financial institution to insure a loan or a debt investment it has made by paying periodic fees to another institution called a protection seller, which is willing to take the risk.The CDS seller, in turn, guarantees to pay the buyer a pre-determined amount if the company that has borrowed money defaults on repayment.
Worlds largest insurance company was in trouble bcoz of these instruments.it had sold CDS worth $440 billion on subprime and other securitised financial papers. Once the subprime borrowers started to default on their loans, investors who had invested in these securitised loans found their securities turn wothless and so they turned to CDS seller AIG to recoup their losses. AIG couldnt make good their losses, as every invstor turned up to demand their repayments at the same time.So it defaulted on $14 billion of CDS.