Shadow Banking Explained

By | October 3, 2016

Shadow Banking Explained

The banking system in India dates back to the last decades of the 18th century. Banking institutions have been operating since then. As we all know, traditional banks are regulated by depository authorities. But did you know that there are non-banking financial companies (NBFC) that provide similar services to those of the traditional commercial banks which are not regulated and these institutions form the shadow banking structure in the country.

Hearing the term ‘shadow banking’ for the first time? Well, we’ll tell you about the different facets of shadow banking and help you understand it.

Shadow banking and the Indian economy

The shadow banking system varies for countries and in most countries, these banking entities are not governed by any regulatory authority. But the shadow banking system is different in India, since the Reserve Bank of India, has a regulatory structure over the NBFCs. There are rigorous registration requirements, close supervision, and detailed reporting of the activities of the NBFCs in India.

The NBFCs in India comprises of the investment, insurance, chit fund, stock broking, and merchant broking companies which act as financial intermediaries to the banks.

Difference between shadow banks and traditional banks

Shadow Banks Traditional Banks
These banks cannot create money, by virtue of deposits, unless they have licences from the RBI. There are limits to the amount of deposit they can garner. These commercial banks can create money, by virtue of the deposits made by their customers.
These banks have lower regulatory oversight and transparency. These banks are extremely well-regulated and transparent with their business operations.
These banks do not have access to the central bank repository or any other funds in times of emergency. These banks are backed by the central government and apex banking authorities, and hence can borrow money from the RBI, during an emergency.
The liabilities of shadow banks are uninsured. Generally, most banks enjoy a certain amount of government backing and the liabilities are insured up to a specific limit.

Dangers associated with shadow banks

While shadow banks act as supplements to the main banking system and bring about a lot of diversity in the financial sector, there are dangers associated with them as well.

  • There are a number of registered finance companies, which are not regulated by the norms and conditions of the RBI.
  • There are incorporated companies and many unincorporated entities that illegally accept deposits from customers, which also form a part of NBFCs.
  • There are unincorporated bodies that undertake financial activities without keeping a track of their transactions.

Since unincorporated entities can come up in any nook and corner of the country, it’s difficult to control them. These entities endanger the customers’ interests and often it can be risky to invest your money with these entities as they are not strictly regulated by RBI norms. Even though the shadow banking system is monitored by the RBI to a certain extent, it’s difficult to regulate this sector owing to the heterogeneous nature of the NBFCs. Moreover, there is no statistical data or consolidated database where you can get a clear picture of the financial transactions done by these NBFCs.

It is one of the constant endeavours of the RBI to regulate this sector in a better way, help control the fraudulent activities, and regularise the financial dealings of these entities.

On the contrary, traditional banking institutions are far more secure and reliable in terms of investment options.

So, in case you have decided to explore some traditional banking investment options, we’re right here with some exciting options and offers!

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