Growth of Shadow Banks Threat to Financial Stability: RBI Report.


Growth of Shadow Banks Threat to Financial Stability: RBI Report.

Shadow banking is a global problem that manifests itself in various ways according to the RBI. The structure of shadow banking or parallel banks is more a transformation of risk through securitization in advanced economies where the financial system is more mature, while the activities are more complementary to banking activities in economically weak economies where the financial market is still in the development phase.

On the other hand, shadow banking operates outside the standard banking system in both structures, and financial intermediation operations are conducted with less transparency and control than traditional banking. Ghost banks are similar to icebergs in that they are more widely dispersed than they appear.

Shadow banks play a major role in credit provision and financial inclusion in developing economies. They can help specialized industries access credits that would otherwise be difficult to obtain. They can link borrowers’ funding demands to investment against formal banking systems, which are constrained by regulatory constraints, and traditional financial system requirements, which are difficult for customers to meet.

Shadow banks, like traditional banks, engage in a variety of intermediation activities, but they are fundamentally different from commercial banks in several respects. First, unlike financial institutions, which are able to produce money because of their status as deposit accounts, shadow banks cannot.

Second, unlike banks, which are heavily regulated, shadow banks are not as well regulated and their business practices are opaque. Third, while commercial banks raise funds mainly through the mobilization of deposit accounts, shadow banks mainly raise funds through market-based products such as commercial paper, convertible notes and other instruments. structured finance.

Non-Performing Raw Leads: Latest News and Videos, Photos on Non-Performing Raw Leads |  the economic situation - page 1Fourth, the liabilities of shadow banks are uninsured, although commercial bank deposits are often guaranteed to a limited degree by the government. Fifth, unlike institutions with immediate access to relevant bank liquidity, shadow banks do not have this recourse in times of crisis.

While there can be important distinctions in how shadow banking and shadow banking work, there is often only a thin line between the two. A regulated bank, for example, can create a special purpose vehicle (SPV) to store specific assets and offload them from its balance sheet.

The Reserve Bank of India (RBI) identified non-banking financial corporations (NBFCs) in its annual report, saying shadow banks’ balance sheets have widened even as asset quality has deteriorated. Additionally, the regulator said some of these companies could pose a risk to economic stability as they have increased in size due to greater risk appetite.

NBFC balance sheets have grown in 2021-22 (through December 2021), while the quality of the sector’s assets has declined. Nevertheless, capital cushions have improved, according to the annual report.

stretched valuations of financial assets pose risks to financial stability: das |  mint

According to the research, the role of NBFCs in supporting real economic activity and as an additional channel for credit intermediation alongside banks is well recognized.

“The increased risk appetite of NBFCs has contributed to their scale, complexity and interconnectedness over time, making some of the companies systemically important and posing a possible danger to financial stability,” according to the research.

In addition to strengthening the quality of their credit portfolios, shadow banks and cooperative banks (UCBs) will need to be vigilant of balance sheet flaws, wherever they exist, and maintain rigorous asset-liability management, according to the annual report of the central bank.

“Given the considerable percentage of funding taken by NBFCs at the system level,” the report states, “continued attention to their fiscal sustainability is warranted from a financial stability perspective.”

In the current fiscal year, the regulator intends to take a number of steps to improve the regulation and supervision of banks and NBFCs. For example, from October 1, 2022, a redesigned regulatory framework for these companies will provide a layered structure based on their size, activities and perceived risk.

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The RBI has also issued recommendations for NBFCs that expand the framework for prompt corrective action. Since Infrastructure Leasing & Financial Services (IL&FS) went bankrupt in 2018 causing a liquidity crunch, the RBI has started to tighten restrictions for the NBFC sector.

The central bank has moved to bridge the regulatory gap between banks and NBFCs by introducing a ladder-based regulatory regime for the sector, in which large NBFCs will face tougher rules due to their importance systemic. Mortgage financier HDFC Ltd has decided to merge with HDFC Bank due to reduced arbitrage opportunities and tougher rules. Many prominent NBFCs in the country have failed in recent years, including DHFL, Srei Group companies and Reliance Capital.

In truth, the shadow banking system is one of the many flaws in the financial system that led to the international economic collapse. In a 2007 talk at the Kansas City Federal Reserve Bank’s annual economic conference in Jackson Hole, Wyoming, economist Paul McCulley coined the term “shadow bank.”

In McCulley’s discussion, the term “shadow banking” referred to non-banking financial entities involved in “maturity transformation,” as defined by economists. When commercial banks use short-term deposits to support longer-term loans, it is called maturity transformation. Shadow banks follow a similar process.

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They use the money markets to raise (or borrow) short-term capital, which they then use to buy longer-term assets. However, because they are not regulated like banks, they cannot borrow from the Federal Reserve (the US central bank) in an emergency and do not have traditional customers whose funds are insured; they operate in “the shadows”.

Many pundits first became aware of shadow banks because of their growing role in converting mortgages into securities. The “chain of securitization” began by creating a mortgage, which was then bought and sold by one or more financial companies until it became part of a pool of mortgages used to secure collateral sold on the open market.

The deposit was tied to the amount of the group’s mortgages, and interest on the mortgage-backed securities was paid from the call while the principal owners repaid their loans. Almost every step of the process, from the origination of the mortgage to the sale of the asset, took place behind closed doors, out of sight of regulators.

The Financial Stability Board (FSB), a group of financial and supervisory authorities of major economies and financial institutions, has developed a broader definition of financial institutions that includes all entities that perform the primary banking function of credit intermediation outside the regulated banking system (i.e. taking money from savers and lending it to borrowers).

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