August 12, 2021: Paul McCulley coined the term “shadow bank” in 2007 and the term refers to the banking and finance services that are delegated to non-banking financial companies (NBFC) which function outside the boundaries of the traditional banking sector and are regulated with a different set of rules. The shadow banking institutions function as intermediaries between the investors and the borrowers, providing credit, thus, leading to financial inclusion and hence generate liquidity in the system.
Some of the popular NBFC firms that operate in India are Muthoot Finance, Bajaj Finserv, Mahindra Finance, Aditya Birla Finance, Tata Capital, L&T etc.
Shadow banking and the functions of NBFCs
- Collections of funds and loans
- Raising funds
- Risk management of economic issues
- Loans and allied services
What is the current situation of Shadow Banking in India?
According to a May 2020 report by ratings agency Moody’s, the inability of borrowers to repay loans amid the COVID-19 pandemic—along with the central bank-approved six-month moratorium on repayment that was in place at the time—would likely lead to a disruption in inflows for NBFCs, despite outflows having to continue.
“Most NBFCs do not have substantial on-balance sheet liquidity because they primarily manage liquidity by matching cash inflows from loan repayments by customers with cash outflows to repay their own liabilities.”
According to CRISIL, Fitch, SBI Research, India could dive into a full-blown recession with Arthur D Little saying it will push 120 million people back into poverty and destroy opportunities of up to 1 trillion dollars in GDP. The RBI states, banks have credit outstanding of roughly 1.92 trillion dollars and hold deposits worth about 1.69 trillion dollars.
The reliefs for financial stability
New measures are being implemented, however. In December, the central bank said it would introduce risk-based internal audits at large NBFCs as well as monitor 100 of the country’s biggest NBFCs rigorously to ensure that financial stability is maintained.
It has also proposed a four-layered structure for regulating NBFCs that takes aim at their capital levels and lending and governance practices with the aim of preventing further defaults.
The new regulatory framework would consist of a “base layer, middle layer, upper layer and a possible top layer”, with no NBFC falling under the top layer unless the risk perception rises to an acute level. NBFC entry requirements could be tightened with the minimum net-owned-funds threshold being increased by tenfold, with the RBI also proposing the alignment between banks and NBFCs of bad-asset identification by lowering the classification down to 90 days from 180 days.
The RBI took several steps, first in April and then in August, to provide relief but there was no moratorium announced for capital market borrowings, which also form a significant chunk for NBFCs. In October, as part of its 20 trillion stimulus package, the government announced liquidity support of Rs 75000 crores to NBFCs – MFIs, to be imparted under two separate schemes. This comes as a relief but the reluctant approach of banks is still a matter of concern.
Further the RBI Governor, Shaktikanta Das has mentioned about the enhanced improvements of the situation of shadow banking in India with only a few NBFCs in question. Apart from that he has mentioned the alleviated situation of the liquidity sector and funding of banks to the NBFCs.