Shadow banking ,mechanism of shadow banking, Rise and growth of shadow banking, Present scenario, Policies responses

1. The Shadow Banking
Under the guidance of:
Bhagat Singh Bisht Sir
Section A , Group 8
Chandni Soni
Manjari Priya
Dheeraj Singh
Rahul Kumar
Ankur Kumar
Rohit Sharma
Akshat KumarSrivastava

2. Overview
Topics Presenter
Introduction Dheeraj Singh
Mechanism of Shadow Banking Chandni Soni
Rise and Growth of Shadow banking in India Manjari Priya
Present Scenario Ankur Kumar
Policy Responses & Interventions in the Indian
Shadow Banking Sector
Rohit Sharma
Funding and Recent defaulters in Shadow
Banking sector in India
Rahul Kumar
Major impacts on shadow banking due to
COVID-19 pandemic & Conclusion
Akshat Kumar Srivastava

3. What is Shadow Banking?
The term “shadow bank” was coined by economist
Paul McCulley in his 2007 speech.
Shadow banking system:
The Nonbanking Financial Institutions (NBFIs) providing banking services operating under
regulatory frameworks other than that of the commercial banks and are known for lending to
comparatively riskier ventures.
• In general, it includes : Investment Banks, Mortgage Lenders, Money Market Funds, Insurance
Companies, Hedge Funds, Fixed Income Funds, Housing Finance Companies (HFCs) etc.
• These financial institutions act like banks are not supervised like banks.
• The shadow banking system provides a free pass to the banks to circumvent any regulation.
• The shadow banking system is said to grow and diminish in size.
However, it never vanishes.

4. Why?
• Competitive pressures force banks to undertake more risks and if possible
earn a higher rate on their investments.
• This is what created a parallel financial universe called the shadow banks.
When did started?
• These firms proliferated mainly when traditional banks were pulling back
from lending due to the imposition of strict norms after the 2007 crisis.
• According to the Financial Stability Oversight Council 2019 report,
nonbanks now originate over half of all new mortgages, which are 10
percent higher than the mortgage lending level of the 2007 financial
crisis.

5. The concept of shadow banking varies across countries:
• In Europe : Lending by insurance companies.
• In China : Wealth management products offered by
banks.
In INDIA
• Shadow banking institutions play an important role by
providing credit to inaccessible areas or to niche
sectors and small industries besides lending to the
established businesses.
• Create simultaneous credit flow in addition to the credit
lines provided by the Scheduled Commercial Banks (SCBs).
• Shadow banking institutions regulated by the RBI include: All-India Financial
Institutions (AIFIS), Non-Banking Financial Companies (NBFCS), Primary Dealers (PDS)
and Housing Finance Companies (HFCS).

6. Few examples of Shadow Banking in India are:
Power Finance Corporation Limited
Shriram Transport Finance Company Limited
Bajaj Finance Limited
Mahindra & Mahindra Financial Services Limited
Muthoot Finance Ltd
HDB Finance Services
Cholamandalam
Tata Capital Financial Services Ltd
L & T Finance Limited
Aditya Birla Finance Ltd etc.

7. MECHANISM OF
SHADOW BANKING

8. The “market view” perspective of shadow
banking
Begin with plain and simple (vanilla) banks.
Here vanilla banks are considered as
intermediaries between savers (lenders)
and investors (borrowers).

9. Banks as financial intermediaries

This model suffers from several problems arising from a mismatch of
characteristics of assets and liabilities of the bank.

First, the asset held by the bank (loan to the borrower) may be long-
term while the liabilities of the bank (deposits held by lenders) can
be withdrawn on demand (short-term).

10. The emergence of shadow banks with
repo arrangements

This arrangement also allowed banks to better match maturities
of assets and liabilities.

It called for mark-to-market monitoring of the government
security price and adjustment of contracts between the shadow
bank and commercial bank.

11. Emergence of a disaggregated shadow
banking system

Begin with borrowers who approach a bank for loans against deposits/cash.

The bank complies. It then sets up a Special Purpose Vehicle or SPV (a distinct entity
from the bank) which buys these loans from the bank, repackages them and sells them
as Asset Backed Securities (ABS) to lenders in the market.

Financial institutions (FIs) like mutual funds, pension funds or insurance companies.

12. The money circuit view of shadow banking


The money view of shadow banking.
This view conceives of shadow banks as institutions which
temporarily close the money circuit by substituting deposits
(liabilities) on the banks’ balance sheets with the loan liabilities of
borrowers (asset to shadow banks).

13. The mechanism of Indian NBFCs

Following the market-view, India’s shadow banks or NBFCs are a network of
intermediaries connecting savers to investors, their vital service being credit
transformations.

More specifically, short-term borrowing through issue of commercial paper (CP) for
longer-term lending in infrastructure projects like roads and highways, power plants,
ports, real estate and so on.

14. RISE AND GROWTH OF SHADOW
BANKING IN INDIA

15. Several factors have contributed to the phenomenal growth
of shadow banks in India.
• The trigger would be 1991 economic reform which saw the
implementation of the three pillars of the IMF’s structural
adjustment program – liberalization, privatization and
globalization.
• The process of liberalization also allowed the interconnection
among as well as between shadow banks and traditional
commercial banks.
• The structural reforms of 1991 triggered the need for alternative
sources of finance to commercial banking and informal sources
of finance.

16. In India, Shadow banking institutions regulated by the
RBI include :
• All – India financial Institutions (AIFIs)
• Non-banking financial companies (NBFCs)
• Primary dealers (PDs) and
• Housing Finance Companies (HFCs)
• In the developing countries like India, NBFCs play supplementary
role to banks.
• When Banks are not able to provide their services due to legal
restrictions, it becomes easy for NBFCs to provide financial
services to such customers.

17. In India, as on 31st March 2019



9,659 NBFCs registered with the RBI
88 were deposit accepting NBFCs
263 systematically important non-deposit
accepting NBFCs.
• As on March 31, 2019, the total assets of NBFCs and
HFCs was Rs 44.4 lakh crore
(NBFCs: 70 per cent; HFCs: 30 per cent)
• Approximately one-fourth the size of the assets of
the scheduled commercial banks (Rs166 lakh crore).

18. GROWTH OF SHADOW BANKS
• Apart from the recent fall in credit growth by the NBFIs
arising out of fund crisis as a fall out of failures of few big
NBFCs.
• But still there was a High Growth till FY 2018.
High Growth Trends In The Indian Shadow Banking Sector Till FY 2018

19. • RBI data shows that the consolidated balance sheet size
of the NBFC sector grew 20.6% to INR 28.8trillion in FY19
as an increase of 17.9% to INR 24.5 trillion in FY18.
• Important source of funds to the NBFCs in India is
commercial banks.
• Apart from banks, the major lenders of funds to NBFCs
are: Mutual funds (MFs), which stood at about Rupees
2,300 billion (US$33 billion8) as at March-end (2018).

20. PRESENT
SCENARIO

21. • In India: $ 190 billion, which is the 15th largest in the world
• At the global level: $52 trillion industry
• A 75 percent increase from the year 2010 level
• Among the BRICS, India has the third-largest shadow banking sector.
As on 31st March 2019.
• 9,659 NBFCs registered with the RBI
• 88 deposit accepting NBFCs
• 263 systemically important non-deposit accepting NBFCs
• 802 NBFCs have asset size INR 100 crore and above
Distribution of NBFC Credit

22. • RBI data shows that the consolidated balance sheet size of the NBFC sector grew
20.6 percent to INR 28.8 trillion in FY19 as against an increase of 17.9 percent
to INR 24.5 trillion in FY18.
• The Return on Assets (RoA) decreased to 1.5 percent as on March 2019, from
1.6 percent as on March 2018.
• Gross NPA of the NBFC sector as a percentage of total advances increased:
From 5.8 percent in FY18 to 6.6 percent in FY19.
NPA percentages are always higher for the SCBs
Trends of NPA in two parallel financial sectors

23. Policy Responses &
Interventions in the Indian
Shadow Banking Sector

24. Few important measures have been taken for the
shadow banking sector during the union budget of
the year 2020.
The asset size has been reduced from INR 500 crore to INR 100 crore
or loan size from existing INR 1 crore to INR 50 lac for debt recovery
under the SARFAESI Act 2002.
Securities will be floated by NBFC under the Partial Credit Guarantee
scheme to infuse liquidity to the shadow banking system.
Necessary amendments will be done to the factoring Regulations Act
2011 to enable NBFCs to extend invoice financing to MSME.

25. Regulations
• The regulations of the shadow banking system are apparently
less stringent worldwide. In India, they are governed by the
Companies Act.
• NBFCs like HFCs, Venture Capital Fund Companies, Insurance
Companies, Chit Fund Companies etc are not required to be
registered under Section 45-IA of the RBI Act,1934.
• The government has advised the public sector banks (PSBs) to collaborate
with shadow banks for loans to SMEs, small traders and microfinance
institutions under the Co-origination scheme.
• Shadow banks will bear a minimum of 20 % of the credit risk by way of
direct exposure
• 80 % by co-originating PSB will take the rest of the credit risk

26.  The importance of shadow banks in financing of much
needed investments in the economy and have therefore
taken adequate steps to allow growth in and deepening of
shadow banking in India.
 The RBI focus in its recent announcements has been to
ensure higher attention on liquidity management by
shadow banks.
 In a latest decision the RBI has increased the ceiling for a
bank’s exposure to a single NBFC to 20% of its tier 1
capital from 15% earlier (Ghosh and Prasad2019).

27.  According to one of India's leading bankers the deft
handling of the situation through asset sales and
government control over IL&FS ensured that it did not turn
into a Lehman moment for India.
 The SEBI has also issued new rules for the mutual fund
industry including mandatory holding of liquid assets (cash
and government securities).

28. Funding and Recent defaulters
in Shadow Banking sector in
India

29. During August 2019, RBI announced two key
measures to help liquidity in cash trapped NBFCs.
It decided to raise a bank’s exposure limit to a single NBFC to
20 percent of tier-I capital of the bank.
Secondly, RBI has decided to grant priority sector lending status
for credit to shadow banks for on-lending to agriculture, SMEs
and housing; and reduced risk weights for consumer loans.

30. Recent defaults in the shadow banking
sector in India
• A 2017 report by the RBI showed that 99.7 percent of
shadow banking in India involves making long-term loans
against short-term funding.
• Collapse of IL&FS in 2018, followed by DHFL, Reliance Home
Finance Ltd and Altico Capital India Ltd all these NBFCs suffered
from the asset-liability mismatch.
• Basel, Switzerland-based Financial Stability Board (FSB): has estimated warning for
Indian Shadow Banking.
• Credit Suisse report : Concentration risks i.e. too much exposure only to few sectors
cause concern.
Loans to housing finance sector are of around 21 percent of NBFCs’ loan book,
compared to 7 percent for private banks and 3 percent for PSBs.

31. Major Impacts on Shadow
Banking due to COVID-19
Pandemic

32. The consequence of the COVID-19 pandemic is going to slow down the
rapid growth of the NBFIs as well as the growth of the entire economy
worldwide.
Most of the NBFCs have already lost close to approximately 30
percent to 40 percent value in the stock market worldwide.
NBFIs heavily relying on digital processing of transactions are
getting their processes disrupted due to hardware shortages from
countries like Korea and China as their activities are stopped too.

33. CONCLUSION

34. The shadow banking sector plays an important role in the Indian
financial system, by providing credit, especially to the retail and
small-company sectors.
The shadow banking sector in India accounts for a relatively small share
of the total assets of the financial system as a whole where the share of
lending by the PSBs accounts for nearly 70 percent of the total assets.
In the end, after the present health crisis is over, under effective and
adequate regulations and sufficient flow of liquidity, the shadow banks
are once again going to pose very tough competition to the traditional
banks.