Shadow Banking | 29 Nov 2019

Shadow banking is a term used to describe bank-like activities (mainly lending) that take place outside the traditional banking sector.

• It is also referred as non-bank financial intermediation or market-based finance.
• Generally, it is not regulated in the same way as traditional bank lending.
• The term ‘shadow bank’ was coined by Paul McCulley in 2007.
• Examples of shadow lenders include Special Purpose Entities, Non Banking Financial Companies (NBFCs), Hedge Funds etc.
• These institutions function as intermediaries between the investors and the borrowers, providing credit, thus, leading to financial inclusion and hence generate liquidity in the system.
  
  • However, the 2008 financial crisis has shown that shadow banking can be a source of systemic risk to the banking system. The risks can be transmitted directly and through the interconnectedness of partially-regulated entities with the banking system.
  • After the financial crisis, central banks including that of USA, Britain and the European Union (EU) have introduced many strong measures to control shadow banking.
• In India, the crisis of the NBFCs that was triggered by the liquidity problems of IL&FS in 2018, has brought back the attention to shadow banking sector.

Source: BS