Shadow banking is credit intermediation
involving entities and activities outside the regular banking system.
The pre-crisis regulatory architecture and regulatory culture provided a
fertile ground for a thriving shadow banking sector to emerge.
Regulators focussed on securing the safety of banks, but it was that
exclusive and straitjacketed focus on banks that opened up
opportunities for regulatory arbitrage in the form of shadow banks which
mushroomed and proliferated without the shackles of regulation. Banks
also found out that it was possible to transfer risky businesses and
assets to the balance sheets of the shadow banks without transgressing
any regulations. But shadow banks were a crisis waiting to
happen because of their low capital base, high leverage,
interconnection with banks and risky business models. According to an
estimate by the Financial Stability Board (FSB), the global shadow
banking system, as conservatively proxied by ‘other financial
intermediaries’, grew rapidly before the crisis, more than doubling
from USD 26 trillion in 2002 to USD 62 trillion in 2007.
The Financial Stability Board (FSB) issued a consultative document in November 2012 on ‘Strengthening Oversight and Regulation of Shadow Banking’ focusing on areas where policy intervention is warranted to mitigate the potential risks associated with shadow banking. The FSB, working with the BCBS and the International Organisation of Securities Commissions (IOSCO), has focused on five specific areas: (i) mitigating the spill-over effect between the regular banking system and the shadow banking system; (ii) reducing the susceptibility of money market funds to “runs”; (iii) assessing and mitigating systemic risks posed by other shadow banking entities; (iv) assessing and aligning the incentives associated with securitisation; and (v) dampening risks and pro-cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of “runs
How have We, in India, Responded?
Do we have shadow banking in India? In a sense yes, in the form of Non-Banking Finance Companies (NBFCs) which perform bank like financial intermediation. But what distinguishes our NBFCs from shadow banks is that unlike shadow banks which emerged and expanded outside of regulatory oversight, India’s NBFC sector has always been regulated, although less tightly than the banking system.
It is important in this context to note that our non-bank financial sector is very large, diverse and complex. Some of it is in the corporate sector, but much of it is in unincorporated. Different segments are regulated by different regulators. Some of the deposits raised by these companies are legal, some are illegal. In the wake of the recent melt down of a few finance companies in parts of the country, in the process destroying the entire life savings of millions of low income households, there is need to review the regulatory oversight of this sector keeping in view the mandatory and relative comparative advantages of the financial sector regulators. While tightening regulation is important, it is not sufficient. What is to be noted is that much of the fraud in the non-bank sector happens through unlawful and fraudulent schemes which should not be operating. This reinforces the importance of surveillance and enforcement, especially by the state governments.
The Financial Stability Board (FSB) issued a consultative document in November 2012 on ‘Strengthening Oversight and Regulation of Shadow Banking’ focusing on areas where policy intervention is warranted to mitigate the potential risks associated with shadow banking. The FSB, working with the BCBS and the International Organisation of Securities Commissions (IOSCO), has focused on five specific areas: (i) mitigating the spill-over effect between the regular banking system and the shadow banking system; (ii) reducing the susceptibility of money market funds to “runs”; (iii) assessing and mitigating systemic risks posed by other shadow banking entities; (iv) assessing and aligning the incentives associated with securitisation; and (v) dampening risks and pro-cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of “runs
How have We, in India, Responded?
Do we have shadow banking in India? In a sense yes, in the form of Non-Banking Finance Companies (NBFCs) which perform bank like financial intermediation. But what distinguishes our NBFCs from shadow banks is that unlike shadow banks which emerged and expanded outside of regulatory oversight, India’s NBFC sector has always been regulated, although less tightly than the banking system.
It is important in this context to note that our non-bank financial sector is very large, diverse and complex. Some of it is in the corporate sector, but much of it is in unincorporated. Different segments are regulated by different regulators. Some of the deposits raised by these companies are legal, some are illegal. In the wake of the recent melt down of a few finance companies in parts of the country, in the process destroying the entire life savings of millions of low income households, there is need to review the regulatory oversight of this sector keeping in view the mandatory and relative comparative advantages of the financial sector regulators. While tightening regulation is important, it is not sufficient. What is to be noted is that much of the fraud in the non-bank sector happens through unlawful and fraudulent schemes which should not be operating. This reinforces the importance of surveillance and enforcement, especially by the state governments.
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