Emergence Of Shadow Banking And Its Impact

What exactly is shadow banking? The term shadow banking was coined by Paul McCulley, an American economist in 2007. According to Financial Stability Board (FSB), shadow banking broadly refers to “the system of credit intermediation that involves entities and activities fully or partially outside the regular banking system”. They generally carry out traditional banking functions, but largely do so outside the regulatory framework and act as an intermediary between investors and borrowers.

According to the FSB report (2014), the size of global shadow banking assets expanded to USD 75 trillion and accounted for about 25 per cent of the total financial assets, roughly half of the banking system assets and around 120 per cent of the global GDP (in select jurisdictions). As per the same report, the United States and the euro region have the largest system of non-bank financial intermediation, each with above USD 25 trillion in 2013. The United Kingdom has the third-largest sector amounting to USD 9.3 trillion. Combined together, the euro region, the United States and the United Kingdom represented 80 per cent of the total global non-bank financial intermediation assets in 2013. The size of shadow banking, though comparatively smaller in most of the emerging market economies, has been growing quite significantly. However, the size of shadow banking in India, as per the FSB report, remained below 20 per cent of its GDP.

Shadow banking activities are very strong in advanced countries. However, they are not that prominent in developing countries like India. There is no clear-cut definition of shadow banking activities in India. In the Indian financial system, what has often been referred to as shadow banking largely comprises non-banking financial companies (NBFCs). These are engaged in the entire gamut of financial activities, including vehicle finance, housing finance, hire purchase, gold loans, unsecured retail and personal loans, insurance, chit funds, nidhis, merchant banking, stock broking, asset financing, alternative investments, micro finance, and money lending, among others. Some of the big NBFCs like infrastructure finance companies are engaged in lending exclusively to the infrastructure sector, factoring business, etc.

There is an ongoing debate whether or not the NBFCs in India are shadow banks. In fact, they have been under the regulatory structure of the Reserve Bank of India (RBI) for over a period of 50 years and they account for a relatively small share of the total assets of the Indian financial system. Over the years, the RBI has taken a number of measures to improve the regulatory mechanism of NBFCs and to bring them on par with the formal banking system. Nevertheless, compared to the banking system, the operations of NBFCs are less regulated and in some cases lack transparency in their operation, disclosures, etc.

That apart, the country has a large unregulated credit market, operating largely in the unorganised sector. This unorganised sector is primarily made up of moneylenders and indigenous bankers. The information about their operations is quite limited because there is no official agency to which they report their operations. They also play a central role in lending to people with less access to banking activities, such as the unbanked or under-banked and in cases where borrowers do not have good credit history or security back-up. However, the rates of interest charged by them are often quite high and vary over a wide range across the country.

The chit funds also play an active role in the financial market, providing both savings and credit facilities. They operate both in the organised and unorganised sectors in India and are popular among low-income households. They help investors to get a higher rate of interest and provide easy access to money during any emergency. However, they always carry a significant risk due to their failure to meet obligations and quite often because of frauds. According to an official estimate, there are more than 30,000 registered chit funds in India, which are regulated by state registrars under the 1982 Chit Funds Act. However, many states do not have an effective mechanism to regulate or monitor such schemes and their operations. Many of these funds continue to evade regulation and there have been several instances of fraud by chit funds in recent days.

India is a bank-dominated economy. The banking system continues to play a dominant role in the Indian financial system. In a country like ours, where financial inclusion is considered as the most important objective, any kind of credit intermediation or credit expansion is quite essential. If NBFCs or shadow banks can do this in a cost-effective way by expanding their activities and reach, it certainly is good for the economy. There is no doubt that the non-banking financial intermediaries, whether we call them shadow banks or otherwise, are expanding their operations and also giving greater competition to the formal banking sector in the country.

Particularly, NBFCs are playing a critical role in extending credit to areas where traditional finance cannot reach. They have emerged as a strong financial intermediary in making financial service accessible to a wider section of the population. They are sometimes even considered as a better alternative to commercial banks for meeting the financial requirements of common people. The main advantages of these NBFCs lie in the lower transaction costs of their operations; their expertise in specialised areas; their quick decision-making; customer orientation; and prompt and quick services. In urban areas too, NBFCs focus on sections quite often neglected by banks. In a nutshell, NBFCs bring the much needed diversity to the financial sector.
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The segment has witnessed considerable growth in the last few years. As per the RBI data, during 2014-15, the aggregated balance-sheet of the NBFC sector expanded by 16.8 per cent. As of March 2015, there were 11,842 NBFCs registered with the RBI, of which 220 were deposit-accepting (NBFCs-D) and 11,622 were non-deposit accepting (NBFCs-ND). NBFCs-ND with assets of Rs 5 billion and above has been classified as systemically important since November 2014. As of March 2015, there were 200 such systemically important NBFC-NDs. According to a recent report by India Ratings, NBFCs are expected to account for 17.1 per cent of the total credit in the country by 2018-19, compared with 13.1 per cent at the end of 2014-15 and 9.4 per cent in 2005-06. Most of this growth is expected to be at the cost of government-owned banks, whose share is estimated to fall to an all-time low of 58.6 per cent by 2018-19 as against 64.5 per cent in 2014-15.

However, in the last few years, the banks have become quite aggressive in their efforts to reach last mile connectivity. They have made significant efforts to expand their financial inclusion agenda by opening fresh branches in unbanked regions, appointing business correspondents to address the problems at the bottom of the pyramid, extending no-frill accounts to all unbanked households by relaxing KYC norms, and so on and so forth. The banks’ forays into hitherto untapped and unexplored areas help in increasing the banking touch points across the country. Besides, a lot of digital inventions and innovations are happening in the banking industry, which is going to help the banks to expand their presence across the length and breadth of the country in a more cost-effective way.

Several initiatives have been taken to ensure that banks reach out to the hitherto unbanked population. Some of these are:

Financial Inclusion:

To attain greater inclusive growth, the government and the RBI have taken many measures to engage banks, and the banking industry has responded proactively. However, a greater impetus to the financial inclusion plan has been possible because of the Pradhan Mantri Jan DhanYojana (PMJDY). PMJDY has brought all the unbanked households into the fold of the formal banking sector.  In a short span of time, banks have opened a record number of accounts. As per the latest available data, 18.86 crore new accounts have been opened with the issue of Rupay cards to 16.26 crore account holders, increasing deposits by Rs 25,693 crore and covering almost 100 per cent of the households across the country. Besides, MUDRA Bank, set up under the Pradhan Mantri MUDRA Yojana, is offering newer opportunities for banks to serve micro and small units and to mobilise viable business from the bottom of the pyramid. It has provided many opportunities to the banks to fund the unfunded and to formalise the informal. 

Digital Banking:

India is going through a transition phase as far as digitalisation is concerned. The digital disruption has enabled banks to innovate in this space, which is coupled with new technology interventions and initiatives. Similarly, we are witness to a mobile revolution where the number of mobile phones far exceeds the population, excluding of course small children and the super senior sections of the society. Banks have already started to aggressively promote the use of different channels, including net banking, mobile banking, branchless-kiosk banking, cards, POS (point of sales) terminals, etc. for helping customers to get their work done anywhere any time. It will also help the banking system to reach a larger section of the community in a cost-effective manner.

The ARM Sector:

A greater thrust on the ARM sector comprising agriculture, retail and MSME continues to play a bigger role in terms of the banking system expanding its reach. Banks have really understood the need for providing adequate and timely finance to the ARM segment for fuelling further economic growth in our country. They are coming out with innovative products and services to support these exponentially growing segments while trying to ensure that customised, cost-effective, innovative, and easy-to-use products and services are offered to all these segments of the population.

New Players:

The license given by the RBI for a new category of differentiated banks viz. the small banks and payment banks is yet another major initiative. These banks are highly segmented outfits as they would cater to the hitherto excluded niche segments of the population and can act as a vehicle of inclusive growth. Most of the applicants who have received ‘in principle’ approval have a technology platform, customer base, infrastructure, expertise, technology, and an adequate capital base. The bank licensing process is likely to be on a ‘tap and flow’ basis in the days to come. This is going to transform the banking landscape and will see rapid expansion of various banking channels.

With greater impetus for financial inclusion and further strengthening of banks’ coverage, the banking system will continue to play a dominant role to expand its presence and widen its activities across the country. The entry of new players in the banking fold would provide further momentum to accessibility of finance and render the credit intermediation process more efficient, thereby contributing to sustainable and inclusive growth.

Corporation Bank is one of the oldest banks in the country, established in 1906 with a motto of ‘Sarve Janah Sukhino Bhavantu’ implying ‘prosperity for all’. With its sound legacy of many decades, the bank has developed a strong connect with the people and has developed an impressive customer base across the length and breadth of the country. The bank is a forerunner when it comes to evolving and adapting to financial sector reforms. The financial inclusion initiatives and branchless banking model taken up by the bank have won wide appreciation and the bank is among the pioneers in this field in India.

Making Jan Dhan Profitable:

Corporation Bank has proved to the country that Jan Dhan is profitable. Under PMJDY, the bank has so far opened more than 25 lakh basic savings bank accounts and out of that, only 24 per cent of the accounts are with zero balance, which is one of the lowest compared to many other banks. Today, with more than 76 per cent of the accounts under the non-zero balance category, the bank’s earnings from these accounts are estimated to be Rs 3.63 crore. The average balance in these accounts is about Rs 3,258 as against the national average of Rs 2,450.
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In order to activate a majority of the accounts under PMJDY, the bank consciously has laid stress on providing financial literacy and counselling in local languages to prospective account holders. Up to 80 per cent of the account holders have registered their mobile numbers, thus enabling the bank to reach out to them more effectively. The bank has also provided Rupay debit cards and passbooks to all the accounts opened under PMJDY. It is also considering PMJDY as an opportunity to cross-sell various banking products to increase and expand the bank’s reach.

Helping Hand to Farmers:

Lending to the farming community continues to be a primary focus area for Corporation Bank. The bank has recently formulated a scheme to help farmers in distress to come out from the clutches of moneylenders. To do so, the bank extends a loan of up to Rs 1 lakh at reasonable rate of interest to farmers for repayment of debt availed from moneylenders at high interest rates. The bank has taken several initiatives, including literacy programmes, to educate the distressed farmers and resolve the problems faced by them. Bank officials, in association with district and local administration, organise village-level ‘Chintana–Manthana’ programme wherein farmers are educated on the relief measures available from the banking system at the time of natural calamities. Branch managers and officials of the bank are in continuous contact with farmers at villages to help resolve their problems either by restructuring the existing loan accounts, sanctioning new loans or meeting any other credit requirements.

Supporting Street Vendors:

Corporation Bank was the first among public sector banks to launch the Mudra Card. The bank has adopted a different method to reach out to the micro units. During a recent camp at Mysore, it noticed that street vendors, especially vegetable and fruit sellers, were paying an exorbitant rate of interest to local moneylenders, working out to almost 10 per cent per day for a small amount of money. The bank surveyed the entire market and then provided Mudra Cards to all of them with limits as per the scheme’s guidelines. Now these people can draw money from any of the bank’s ATMs in the morning, conduct their business and remit the amount in the evening or any time during the day through the cash deposit machine, thus saving a significant amount that otherwise would have been paid as interest. The bank is utilising the services of business correspondents (bank mitras) for all such last mile activities, thereby replacing moneylenders and other intermediaries.

Technology Initiatives:

The bank also is a forerunner among public sector banks in implementing technology-driven deliverables to customers. Its technology initiatives, including mobile banking, SMS banking, missed call facility for balance enquiry, e-passbook, tablet banking, e-mandate, etc. are designed to meet the changing needs of different sections of its customers. The bank has operationalised a good number of e-lobbies with self-service kiosks having a cash deposit machine, cheque deposit machine, passbook printer and an ATM to improve the customer convenience factor. E-lobbies facilitate the bank’s customers and public to deposit cash into any account maintained with the bank at any time. The bank’s customers can print their passbook through the self-service passbook-printing kiosk and can deposit cheques of any branch of the bank in a hassle-free manner. It offers a ‘no queue’ service whereby customers can carry out their transactions as per their convenience