shadow banking

Shadow banking is a universal phenomenon, although it takes on different forms. In advanced economies where the financial system is more matured, the form of shadow banking is more of risk transformation through securitization; while in the economically backward economies where financial market is still in a developing stage, the activities are more of supplementary to banking activities. However, in both the structures, shadow banking operates outside the regular banking system and financial intermediation activities are undertaken with less transparency and regulation than the conventional banking. In a sense, shadow banks are like icebergs - more deeply spread than what they seem to be.shadow banks raise funds, by and large, through market-based instruments such as commercial paper, debentures, or other structured credit instruments.The liabilities of the shadow banks are not insured, while commercial banks’ deposits, in general, enjoy Government guarantee to a limited extent.The type of entities which are called shadow banks elsewhere are known in India as the Non-Banking Finance Companies (NBFCs). Are they in fact shadow banks? No, because these institutions have been under the regulatory structure of the Reserve Bank of India, right from 1963 i.e. 50 full years before many in the world are thinking of doing so!The ‘NBFCs’ of India include not just the finance companies, but also a wider group of companies that are engaged in investment, insurance, chit fund, nidhi, merchant banking, stock broking, alternative investments etc. as their principal business. NBFCs being financial intermediaries are playing a supplementary role to banks. NBFCs especially those catering to the urban and rural poor, namely NBFC-MFIs and Asset Finance Companies have a complimentary role in the financial inclusion agenda of the country. Further, some of the big NBFCs viz; infrastructure finance companies are engaged in lending exclusively to the infrastructure sector, and some are into factoring business, thereby giving fillip to the growth and development of the respective sector of their operations. In short, NBFCs bring the much needed diversity to the financial sector.

To summarise, the shadow banks in India (i.e. the NBFCs) are of a different type; they have been under regulation for more than 50 years; they subserve the economy by playing a complimentary and supplementary role to mainstream banks and also in furthering financial inclusion. Yet, they do pose dangers, but of different variety; it primarily relates to consumer protection. It is the constant endeavour of Reserve Bank to enable prudential growth of the sector, keeping in view the multiple objectives of financial stability, consumer and depositor protection, and need for more players in the financial market, addressing regulatory arbitrage concerns while not forgetting the uniqueness of NBFC sector.