Shadow Banking

What is Shadow Banking:

If we go to read the Wikipedia page on Shadow Banking, we shall have a dismal picture as they have been related to the "sub prime crisis" of the previous decade. It has been defined over there as follow:

" Shadow financial system consists of non-depository banks and other financial entities (e.g., investment banks, hedge funds, money market funds and insurers) that grew in size dramatically after the year 2000 and play an increasingly critical role in lending businesses the money necessary to operate"

We all can understand from the media reports & news frequently appearing in newspapers that Government of India's approach to achieve 100% Financial Inclusion has not yielded much desired results.

• Along with the another reasons, there is a fundamental flaw in the approach of the Government.
• This fundamental flaw is to force the mainstream commercial banks to serve the poor, (means rural poor).
• But practically, most of the commercial banks have no interest, skills and capabilities to serve the poor families belonging to rural areas due to an array of reasons such as lack of financial viability, absence of the employees who understand the needs of poor families earning less than some 60-70 thousand per year.
• Besides, the commercial banks are not likely to prefer to extend unsecured credit to the poor.

Shadow Banking in Indian Context:

He we talk about an alternative to the commercial banking system. This alternative banking system can be referred to as 'shadow banking' systems, which are already in place in India and working effectively.

• In Indian Context, Shadow Banking includes non-banking financial companies (NBFCs) focused on serving low-income families and small businesses (like kirana shop owners, truck drivers, tailors, repair shops, agriculturists), MFIs, chit funds, credit cooperatives, etc.

But in India, the alternative delivery systems need to be strengthened. There should be collaboration between the mainstream banking system with alternative delivery systems for last-mile delivery of financial services, particularly credit delivery to the poor.

Challenge of Regulation of Shadow Banking System in India:

In India, the most important regulatory challenge is to ensure ‘greater consistency in regulation of similar instruments and institutions performing similar

activity’ to prevent or contain regulatory arbitrage. In the case of systemically important non-deposit taking NBFCs (NBFCs-ND-SI), a gradually calibrated regulatory framework in the form of capital requirements, exposure norms, liquidity management, asset liability management and reporting requirements has been extended, which has limited the space for regulatory arbitrage as also their capacity to leverage.

Given the increasing significance of the sector, the supervisory regime for the systemically important NBFCs will need to be strengthened further for a more robust assessment of the underlying risks.

Usha Thorat Committee on Shadow Banking

A Working Group under the former Deputy Governor, Smt. Usha Thorat on NBFCs has, inter alia, examined the issues related to the regulatory gaps and arbitrage opportunities that exist in the system, and has given recommendations for addressing these issues as well as for enhanced disclosure  requirements and improved supervisory practices, etc.