Shadow Banking in India. An Analytical Study

Shadow Banking in India: An Analytical Study

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ABSTRACT

After the horrible experience of great financial crisis of 2008, the world has now become more anxious and serious about the existence, contribution, magnitude, significance and risks of non-banking financial sector (NBFS). The sector was neglected from the beginning either by default or by deliberate choice but now the sector has enhanced attention, monitoring and regulation as a post crisis lesson. In this context, raising of boundaries of non-banking financial companies (NBFCs) came up with the risk of evolution of shadow banking. However, the concept of ‘shadow banking’ came into existence in 2007; when Paul McCulley coined the term ‘shadow bank’. Shadow banking includes credit intermediation involving entities (NBFCs) and activities (fully or partially) outside the regulated banking system of any country.

In the developing economies like India, shadow banking play a gainful role in credit delivery and financial inclusion. They play substitute as well as complementary role for commercial banks as they able to fulfill the needs of borrowers outside the preview of regulated banking system. However, shadow banking becomes very risky because it operates outside the regulated banking system and financial intermediation activities are undertaken with less transparency and regulation than the conventional banking. Up to certain level, it helps the financial system to grow; but beyond it, may prove dangerous. This paper focuses on the concept of shadow banking and its prevailing structure and effects in India.

Key words: financial system, NBFCs, NBFS, shadow banking, shadow banks

Shadow Banking in India: An Analytical Study

1. Introduction:

One of the most crucial matter discussed nowadays among the economists at global level is the occurrence of shadow banking in large extent among world economies. Shadow banking is a blanket term, which refers to the financial intermediaries involved in facilitating the creation of credit across the financial system without any direct regulations i.e. non-banking financial sector (NBFS) (Investopedia, 2016). After the horrible experience of great financial crisis of 2008, the world has now become more anxious and serious about the existence, contribution, magnitude, significance and risks of NBFS. The sector was neglected from the beginning either by default or by deliberate choice but now the sector has enhanced attention, monitoring and regulation as a post crisis lesson. In this context, raising of boundaries of non-banking financial companies (NBFCs) came up with the risk of evolution of shadow banking (Gandhi, Danger Posed by Shadow Banking Systems to the Global Financial System - The Indian Case, 2014).

Shadow banking, on the other side, plays constructive role in the countries with underdeveloped financial system of where banks are reluctant to lend because of too many regulations and lack the capital to repair their balance sheets (Sender, 2016). In the developing economies like India, shadow banking play a gainful role in credit delivery and financial inclusion. They play substitute as well as complementary role for commercial banks as they able to fulfill the needs of borrowers outside the preview of regulated banking system (Gandhi, Danger Posed by Shadow Banking Systems to the Global Financial System - The Indian Case, 2014). However, shadow banking becomes very risky because it operates outside the regulated banking system and financial intermediation activities are undertaken with less transparency and regulation than the conventional banking.

2. The Concept of Shadow Banking:

The term “shadow bank” was coined in 2007 by Paul McCulley of PIMCO, a big bound fund to describe risky off-balance-sheet vehicles hatched by banks to sell loans repackaged as bonds. Today, the term is used more loosely to cover all financial intermediaries that perform bank like activities but are not regulated as banks. The shadow banking system consists of a web of specialized financial institutions that conduct credit, maturity and liquidity transformation without direct, explicit access to public backstops (Ashcraft, 2012). The first articles on shadow banking appeared in 2008 (Pozsar A, 2008). Activities of shadow banks includes a web of specialized financial institutions that channel funding from savers to investors through a range of securitization and secured funding techniques. Although a shadow banks (the institutions that constitute the shadow banking system) conduct credit and maturity transformation similar to that of traditional banks, they do so without the direct and explicit public sources of liquidity and tail risk insurance. Shadow banks are therefore inherently fragile, not unlike the commercial banking system prior to the creation of the public safety net (Pozsar Z, 2010). Many authors have given definitions of shadow banking in different context that can be separated as shadow banking activities, shadow banking entities and both. Following figure 1 presents the overview of definitions of shadow banking given by different authors

Figure 1: Different Definitions on Shadow Banking Abbildung in dieser Leseprobe nicht enthalten

3. Global Perspective:

At global level, assets of financial entities considered as shadow banking under the economic functions approach is 26 jurisdictions continued with upward trend, increasing $1.1 trillion in 2014 and reaching $36 trillion. Apart from this aggregate global shadow banking assets in these jurisdictions have increased on average by $1.3 trillion each year since 2011 (FSB, 2015).

Figure 2: Assets of Financial Intermediaries (NBFIs) Globally

Abbildung in dieser Leseprobe nicht enthalten

Source: National Financial Accounts; FBS

The growth in shadow banking assets globally in 2014 occurred against the backdrop of a slight decline in global banking system assets. After increasing significantly in 2011 and 2012, global banking system assets in 26 jurisdictions remained roughly stable in 2013 and decreased slightly in 2014, reaching $135 trillion (Birnbaum, 1998).

Figure 3: Financial Assets of Intermediaries (NBFIs) Globally

Abbildung in dieser Leseprobe nicht enthalten

Source: National Financial Accounts Data, FBS

As a share of total financial system, shadow banking based on the economic functions measures remained relatively constant in recent years at about 12%. However, the shadow banking to GDP ratio has raised from 55% in 2012 to 59% in 2014 as the steady growth of shadow banking in recent years has outpaced GDP. The growth of shadow baking associated with economic growth in recent years. Adjusted for exchange rate effects, jurisdictions with a greater increase in shadow banking assets between 2010 and 2014 tended to have greater increases in GDP over the same period (Tobias Adrin, 2010).

4. Shadow Banking in India:

In India, NBFCs derives a broader meaning. It not just include 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 principle business. In the developing countries like India, NBFCs play supplementary role to banks. Because where the banks are not able to provide their services due to legal restrictions, it becomes easy for NBFCs to provide financial services to such customers. Apart from that, many NBFCs linked to insurance, housing, infrastructure and micro finance sector. Therefore, NBFCs provides much needed diversity to the financial sector.

Figure 4: Registered NBFCs in India with RBI

Abbildung in dieser Leseprobe nicht enthalten

Source: Statistical Data, RBI

Total number of NBFCs as on September 30, 2015 are 11,769, of which deposit taking NBFCs are 239; and non-deposit taking NBFCs with asset size of Rs. 100 crore and above are 432. Non-deposit taking NBFCs with asset size between Rs. 50 crore and Rs. 100 crore are 310 and those with asset size less than Rs. 50 crore are 10994. The average leverage ratio of NBFCs stood at 2.91, return on assets stood at 2.4%, return on equity stood at 9.20% and the gross NPA as a percentage of total credit exposure stood at 2.9%.

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^[1] This paper was presented at the UGC sponsored one day National Conference – Emerging Issues in Commerce organized by Gujarat Commerce College, Ahmedabad (Gujarat) India on 3rd September 2016