SHADOW BANKING - LOOMS LARGE IN MURKY LANES

By Ruma Dubey

Everything that we see is a shadow cast by that which we do not see.

That is the real truth, be it about us as human beings or even in the corporate world.  There always exists a murky, dark shadow behind everything which looks bright and sunny.

The Indian banking system may not be looking particularly sunny currently but there is a shadow of this banking which is not just thriving but booming business. Yes, known as shadow banking, it is the alternative banking, used by majority of Indians. RBI data stated that assets of more than 12,600 NBFCs increased at a compound annual growth rate of 23% between 2005 and 2010, reaching $122 billion, equivalent to 11% of total bank assets. The issue of shadow banking can best be explained by the Sahara group, which raised $3.15 billion worth of bonds it sold, mostly to poor Indians, between 2008 and 2009, for which it is currently under fire from SEBI.

State Bank of India, with over 14,000 branches is stated to be the bank with the largest network. Yet, of the six lakh villages in India, only about 10% of this population has access to a bank branch. The Govt launched the ‘no-frill’s account with a lot of fanfare but of the 74 million such no-frills accounts opened last fiscal, only 3 to 20%, on an average are stated to be operated actively.

This means, people either do not make money at all, do not save which is they do not banks or they make money and need money, but they prefer to get the services from the unorganized money lenders or other forms of unorganized banking. Micro financing to a large extent was the money provider and thanks to the SKS fiasco, there hangs a huge shadow over this sector. Chit funds are another major source of shadow banking. But essentially, in rural India, banking not done through registered banking system is known as ‘shadow banking’.

Apart from Sahara, there are scores of others – CRB, Limousine, Stock Guru, the various Ponzi schemes. Just do a google on ‘money lenders in India’ and it throws up over 2.5 crore hits. This probably indicates how dark and deep rooted this shadow banking really is.

And do not for even a second think that this exists only in rural India. It is does booming business, sometimes better than banking systems in cities and metros and even the developed countries of USA and Europe.

Shadow banking comprises of unregulated or poorly regulated financial outfits, providing credit with no protection whatsoever for the user. This includes money market funds, private equity funds, hedge funds, securitisation, repurchase agreements, securities lenders, and structured investment vehicles. Many tend to include even brokerage houses and NBFCs in this category. Shadow banking allows banks to carry out business off balance sheets and allows investors to bypass lenders and the functions they traditionally fulfill on the markets.

One cannot brush off shadow banking and call it another ‘evil’ of the society because this form of banking is needed; it fills the gap where the regular banks fail. It provides the much needed liquidity to that who do not have access and that is a very important function. But that does not mean they are ‘saints’ either. They are indirectly linked to the baking system and thus when they leverage themselves to the hilt, it increases risk to the entire financial system. These shadow banks, through intermediation chains are linked to the traditional banks and thus when these shadow banks fail; it could unknowingly jeopardize the entire banking system. In fact Economist Paul Krugman had stated that a run on shadow banks was at the core of what happened to bring about the global financial crisis of 2008.

In fact the Financial Stability Board (FSB) has put out a report today stating that shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought. USA and Europe are working out strategies to bring this shadow banking out of the shadows and get it more regulated. The recommendations for G20 leaders on regulating shadow banks are due to be finalised by Dec 2012. At home, RBI is also looking at increasing the surveillance on shadow banking and said that though it is ‘pro- NBFCs’, but they being part of the shadow banking system,  regulations might have to be tightened under Basel-III norms, proposed to become applicable from 2017-18.