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Current Affairs

Shadow banking

Date: 20 January 2021 Tags: Miscellaneous

Issue

RBI is likely to propose tightening rules on "shadow banks" in a bid to strengthen solvency and sustainability.

 

Details

  • India's banks must maintain at least 18% worth of deposits that they must hold in cash, gold or government securities.

  • The RBI could also suggest large nonbanks be required to maintain a cash reserve ratio. For banks this ratio is 3%, reduced from 4%

  • The move could be a huge cash drain for the sector which is currently free from maintaining these reserve ratios, allowing them to lend to subprime lenders as well.

  • The move is to avoid failures of big shadow banks that could pose systemic risks and is expected to encourage some of the larger ones to move towards becoming full-time banks.

Shadow banking

  • The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. 

  • They rely on short-term funding provided either by asset-backed commercial paper or repo market.

  • The shadow banking system has escaped regulation primarily because unlike traditional banks and credit unions, these institutions do not accept traditional deposits.

  • Examples of intermediaries not subject to regulation include hedge funds, unlisted derivatives, and other unlisted instruments.

Difference with conventional banks

  • They do not have access to central bank funding

  • They do not have safety nets like deposit insurance

  • They do not take deposits from customers foe lending

Concerns with Shadow banking

  • They are used to launder money and bypass banking system.

  • Stress on shadow banking will impact traditional banking system.

  • Excess dependency on collateral business will create NPAs.