Shadow Banking

  • March 30, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Shadow Banking

Subject: Economy

Section: Banking Policy

Why in the news?

Infrastructure Leasing & Financial Services Ltd (IL&FS) has addressed debt resolution of Rs 55,000 crore, or nearly 55 per cent of the debt, after the group became a defaulter, and the government superseded its board in October 2018.

Issue?

Shadow banks were first hit in 2018 when a major infrastructure financier IL&FS Group defaulted. Risks roared back when Dewan Housing and Altico Capital India Ltd. also failed to honor debt repayments the following year.

Shadow lenders fund a wide range of businesses from small holiday tour operators to property giants, any setback would not bode well for the economy as a whole.

Non-bank finance companies and housing finance firms are the largest borrowers of funds from the nation’s financial system, hence any failure of a shadow lender could act as a solvency shock to their banks.

Causes of shadow banks crisis?

  • Liquidity crunch-After the IL&FS collapse, the entire sector is facing a crisis of confidence. Several shadow banks are finding it difficult to raise money from banks, mutual funds and the rest of the financial system.
Shadow Banks are so called because they work almost like Banks except that they are not as broad based in their reach as the latter. For instance, both Shadow Banks and NBFCs take deposits and extend loans, though their area of focus is narrower than the traditional banks.

In addition, the Shadow Banks and NBFCs often lend to high risk borrowers with poor credit history as well to projects that are not as gilt edged as those that the traditional banks lend to.

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 generating liquidity in the system.

economy Shadow Banking