#dnaEdit: Shadow banking

Although Reserve Bank of India’s latest Financial Stability Report assures that India’s financial system stability is not in question, a detailed reading of the report by a general reader of this newspaper — who happens to be a bank depositor rather than a lender — will make one a little nervous. This is because of some developments which the report has very effectively documented.

First, the state of the public sector banks, brought out by the report is none too robust. Their non-performing assets are high, their earnings levels are low, provisions for doubtful loans are consequently meagre and they need a large infusion of capital of over Rs4.15 trillion, which, it is not too clear how should be raised. The word of comfort is that if overall growth recovers the banks should see better days as NPAs should then come down. 

The weaknesses are rather well known and have been commented upon by almost everyone from the IMF to credit rating agencies. The problem is that the government is often aggravating these rather than helping their correction. Recall for example a recent government decision to offer over Rs4,400 crore to the beleaguered sugar industry which is more likely to become bad debt than a paying one. 

Secondly, new technologies available are helping morph traditional forms like informal market lending and borrowing into what it has described as shadow banking. RBI has also called for a survey of such financial activities to ascertain their incidence and volumes of transactions. 

Many of these latest activities are Internet based and defy any current regulation. As long as these transactions are of nominal value, any potential irregularities can be contained. However, if these become large in volume, as indications suggest and they have the potential to be so, it could threaten to  create large-scale imbalances.

Informal and unregulated banking is causing major headaches elsewhere as well. In China the incidence of shadow banking has become so large and ubiquitous that the authorities are mulling on controlling their activities. RBI had noted that unrelated individuals come together online and they offer and borrow funds through online organisers. The report referred to “crowd funding” a new nomenclature for lending when “small amounts of money from a large number of individuals/organisations are raised to fund an art work, social cause or start-up venture through web-based platforms.” 

Then there is what is known as peer to peer lending. This is carried out through websites of such lending companies, using different lending ‘platforms’ which charge a relatively small commission for their services. These companies also offer customer services.

The alliance between technology and finance is therefore heading towards a new paradigm with the emergence of such disintermediation. 

Of course, this has not been unknown in India where money had been offered and borrowed in traditional hundi markets or cooperative credit societies. The difference is that this is now happening through online technology platforms and this has, therefore, morphed this limited activity into a cyberspace-based activity which has huge potential to proliferate and handle vast funds. 

The problem is, as RBI observed, there is the popular perception that all such activities are well regulated by the official regulators. As a matter of fact they are not. Therefore, in case of some irregularities and failures, the spillover effect of these activities could reach much wider circles and affect the overall financial stability.