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Shadow Bank – Financial Sector of India & NBFC Contribution on it

NBFC Contribution
Swarit Advisors
| Updated: Dec 05, 2017 | Category: NBFC

If any institution which looks like a bank, acts as a bank and behaves like a bank then it is not necessary that is a bank it can be Shadow Bank.

What is Shadow Bank?

The concept of Shadow Bank was prevalent in UK, Europe, and China. Shadow Bank can be defined as an entity outside the regulated banking system that performs the core banking function of credit intermediation i.e. to take money from savers and lending the same to the borrowers. They are known as shadow bank because there was little transparency as it was often not clear who owned what to whom. Most of their assets and liabilities were off Balance Sheet.

Features of Shadow Bank were:

  • Lack of disclosure and information about assets.
  • Non- transparent governance and ownership structure.
  • Lack of regulatory supervision.

The concept of Shadow Bank came into the scene when there was a financial crisis in the year 2007-08 they receive the attention of people, because of their role in precipitating the crisis. Demand for regulating such banks increased. People, Government, Politicians were of the view that anything that does like a bank or acts like a bank should be regulated like a bank.

The concept of Shadow Banks in India:

The concept of shadow banks was also prevalent in India because we have financial institutions which accept deposits and extend credit like banks but we don’t call them shadow bank we call it Non- Banking Finance Companies (NBFCs).

But they cannot be said to be Shadow Bank because NBFCs are under the regulatory supervision of Reserve Bank of India.

Regulation of NBFCs in India:

In India during the year 1960, there was a failure of several banks, many depositors lost their money. The Reserve Bank of India formed the Deposit Insurance Corporation which provided a guarantee to depositors, at this time Reserve Bank noticed that there were deposit-taking activities undertaken by non-banking companies. So in the year 1996, the Reserve Bank started to regulate NBFCs also and the regulatory provisions for NBFC in India were rigorous.

NBFCs in India:

NBFC is a Non-Banking Financial Company which the principal business of which is:

  • Lending money.
  • Investing in shares/stocks/bonds/debentures.
  • Leasing hire purchase.
  • Doing an insurance business, chit business.
  • Receiving deposits under any scheme or arrangement.

Note: NBFC is regulated by Reserve Bank of India[1].

NBFCs being financial intermediaries are engaged in the activity of bringing the saving and the investing community together. NBFC’s as a financial intermediary play a complementary role to banks rather than competitors. As the majority of the population do not have access to financial products and services including bank accounts, therefore, it is necessary to go beyond areas where there is the lesser number of banks or no banks.

In short, it can be said that NBFC diversifies the risks, increase the liquidity in the market thereby promoting financial stability and bringing efficiency in the financial sector.

Role of NBFCs in Financial Inclusion

Financial inclusion has been defined as the provision of affordable financial services to those who have been left unattended or under-attended by formal agencies of the financial system. These financial services include payments and remittance facilities, savings, loan, and insurance services. Microfinance has been looked upon as an important means of financial inclusion in India. Microfinance is not just provision of microcredit but also other services in small quantities to the poor i.e. providing essential financial services to the poor in an affordable way.

We have enabled non-bank entities as Business Correspondents of banks to achieve the larger goal of financial inclusion. While the new banks that are being envisaged would definitely give a fillip to the country’s financial inclusion initiatives. It has been observed that each of the channels be they large National Banks, regional cooperative banks, or Non-Banking Financial Companies (NBFCs) have a great deal of continuing value to add by focusing on its own differentiated capabilities and accomplish the national goals of financial inclusion by partnering with others.

Role of NBFCs in Capital Market

Around 16% of the total asset of NBFC comprises of investment. This 16 % of the investment is mainly in the capital market. There are specialized NBFCs that are exclusively engaged in capital market investment i.e. trading in securities. These NBFCs, therefore, help in giving liquidity to the capital market. Further, NBFCs also lend money to investors for investing that amount in the capital market.

Role of NBFCs in Financing of Vehicles

NBFC’s that are classified as Asset Finance Companies have gained the expertise in this sector/segment and they play an important role in providing a livelihood to customers.  To encourage the productivity of this kind of NBFC’s the Reserve Bank have accorded certain additional dispensations to them in the form of enhanced bank credit and higher exposure norms.

Role of NBFCs in Infrastructure Financing

NBFC’s which are exclusively involved in financing the infrastructure sector are Infrastructure Finance Companies and Infrastructure Debt Funds. These type of companies are having expertise in long-term financing. Reserve Bank of India after recognizing their importance has given them dispensations in the form of enhanced bank credit, higher exposure norm ceiling and provision of ECB under automatic route for on-lending to the infrastructure sector. The asset-liability pattern of this sector is, however, a matter of concern as these are lending long-term against comparatively shorter-term liabilities.


To grow in a prudential manner while not stopping any other financial innovation is one of the biggest challenges for NBFC. The key lies in having in place adequate risk management systems and procedures before entering into risky areas. Presently the Bank is in the process of reviewing the existing regulatory framework in the context of recent developments of NBFC.


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