Abstract: - Shadow
Banking in Indian context is examined with its niche role to play and exploring
the advantageous function of shadow banking to harness the synergies between
them and the organized banking system; and India being the fastest growing
among in shadow banking world, with increasing regulatory supervision ,
controls along with legislations , and
in the midst of NBFC-Banking Regulatory convergence, this study made an effort
to know the current regulations and legislations in the financial architecture,
as to regulatory gaps, overlaps, inconsistencies and seek to find probable solutions which
provides opportunity for regulatory arbitrage in the context of emerging
Institutions like :- Financial Stability and Development Council (FSDC)
and Unified Financial Authority (UFA) proposed under the Indian Financial Code
Bill 2013.
Introduction
The “shadow banking system”, can broadly be described as
“credit intermediation involving entities and activities outside the regular
banking system”. Intermediating credit through non-bank channels can have
advantages. Thus, the shadow banking system may provide market participants and
corporate activities with an alternative source of funding and liquidity1
The term ’shadow banking system‘ was first used in 2007, and
gained popularity during and after the recent financial crisis, as it
highlighted the bank-like functions performed by entities outside the regular
banking system. The more comprehensive definition, as adopted by the Financial
Stability Board (FSB), i.e., ‘credit intermediation involving entities and
activities (fully or partially) outside the regular banking system’ has been
globally accepted. Thus, shadow banks comprise entities which conduct financial
intermediation directly, such as finance companies or NBFCs, and entities which
provide finance to such entities, such as mutual funds. Globally, shadow
banking entities could be covered under the broad heads of (i) Money Market
Funds, (ii) Credit investment Funds, Hedge Funds, etc, (iii) Finance Companies
accepting deposits or deposit like funding, (iv) Securities brokers’ dependent
on wholesale funding, (v) Credit insurers, financial guarantee providers and
(vi) Securitisation vehicles.
India has a very complex credit system, and it consists not only of formal networks of
public and private commercial banks, regional rural banks, cooperative banks,
public financial institutions such as National Bank for Agricultural and Rural
Development (NABARD), National Housing Bank (NHB) and Small Industries
Development Bank of India (SIDBI), and NBFCs, but also of quasi‐formal and
informal (even illegal, but socially accepted) networks of Nidhis, Chit Funds, Badla Financiers ,Commodity Trade Financiers,
Gold Saving Companies, Gold Loan Companies, Pawn Brokers, Plantation Companies,
Money Lenders and many others3. It is estimated that India has 96 scheduled
commercial banks (SCBs)—27 public sector banks 31 private banks and 38 foreign
banks—having a combined network of over 53,000 branches. According to a report
by ICRA, public sector banks hold over 75% of the total assets of the banking
industry, with the private and foreign banks holding 18.2% and 6.5%,
respectively.
Literature review
Literature Review is
the study of the various papers, articles, journals and websites. The data for
this purpose has been collected from articles in the newspapers, papers,
journals and websites on related of NBFCs and of RBI.
Krishnamurthy.S (2003) analysed that Kotak Mahindra getting
of license to operate as a NBFC has led to an initiative in direction of NBFC’s
conversion in to banks. Now, other large profitable NBFCs such as Sundaram
Finance, Ashok Leyland Finance and Cholamandalam Finance should try to avail
this option in future for competition sake. Though the initial cost would be
high as there higher capital requirements.
Sridhar.R (2006) reviewed
that mostly NBFC’s target niches, as they are oriented towards customers and
try to keep the cost low, so they can be targeted to tap unbanked areas also.
He exemplified the growth story of Shriram finance Group. of being converted to
top tycoon in NBFC world with a credit worth of 5000 cr. According to him these
institutions have to maintain a higher CAR ratio compared to banks, as they are
more risky.
Dubey.S (2007) analysed that Nbfc’s in India had a great
revolution after 1991 liberalization which led to simple regulatory mechanisms
and allowance to greedy investors to park their money with NBFC’s. With more
customers base and unwise investments start rising to have large profitability.
This in turn leads to weak not compatible with strong players and fading of
golden era for NBFC’s.
Aggarwal. M (2010) reviewed that the private banks
conversion in to banks is very risky decision for RBI. As per Official
estimates only 30,000 of the total 6, 00,000 habitations in the country are
exposed to banking services; therefore the RBI has mainly targeted this effort
towards rural India.
Research methodology
Research is the systematized efforts to gain new knowledge.
A Research Methodology defines the purpose of the research, how it proceeds,
how to measure progress and what constitute success with respect to the
objectives determined for carrying out the research study. The appropriate
research design being formulated is detailed below.
The secondary data in this project has been collected from
the ―The Indian banker‖ journal, ―The RBI bulletin‖, ―RBI Discussion papers‖,
―and journals of finance.
Research design
The research design
used for the study is descriptive research design as its main objective is to
describe something. In this research design it is assumed that researchers are
having prior knowledge of the field of study.
The Purpose of the Study
This study made an effort to know the current the regulatory
gaps, overlaps, inconsistencies as to regulations in the shadow banking
financial architecture are examined, and probable solutions which provides an
opportunity for regulatory arbitrage is suggested.
Shadow Banking in India.
India is the world’s second-fastest-growing market, after
Indonesia, for lending outside the banking system, or in the shadow banking, as
such; it also poses risks for a country where 65 percent of the population and
92 percent of small businesses don’t have access to banks. Hence, Non-bank
Finance Companies accounting for almost 40 percent of India’s financial system,
and policy makers are struggling to tame inflation and to reverse slowing
growth. The line between formal and informal banking is blurred, pointing to
India’s huge dependence on shadow banking. Formal banking hasn’t reached rural
places, and there’s latent demand for financial services, which the banking sector
would take 30 years to meet. Without shadow banking, the stability of the
Indian economy and its banks comes into question. The official figure for
India’s shadow-banking industry counts only what non-bank financial companies
register with the central bank. The Gold Loan NBFCs surge as people who once
paid rates to money-lenders as high as 48 percent have turned to NBFCs. Approximately,
70 percent of outlets in Gold Loan Companies like Muthoot Fin Corp are in rural
and semi-urban areas, and they cater to customers in ways banks can’t imagine
by way of services to their doorstep, and for rural customer, lost time is lost
money.
The true size of Shadow Banking is much larger, including
private lending and money channelled into collective investment funds known as
chit Funds. India’s chit-fund association estimates that the country has 15,000
kitty-party companies which together manage billions of dollars’ worth of
funds. M/s Shriram Capital Ltd, one of the largest players, operates in four
southern states and manages over $800m 7. Being indigenous financial
institutions in India, it caters to the financial needs of the low-income
households, which have been excluded from the formal financial system. Chit
Funds address gaps left by the traditional banking sector. They mobilize huge
amounts of small savings, and in return allow members to have access in the
form of loans to lump sum amount of money that they would often not be able to
get from traditional banks. Easy accessibility and flexibility are important
aspects of this form of financing. Compared to banks, Chit Funds require less
documentation, are more flexible about collateral, and allows to determine own
interest rate (within the constraints of a given chit scheme). Furthermore,
there is no need to determine upfront whether funds are used for saving or
borrowing. This is a salient feature of chit funds as it not only puts in place
a disciplined saving mechanism, but it also allows to access cash when needed.
The constraints faced by the formal financial system in
reaching rural households in a flexible and
Hassle-free manner led, almost as a natural consequence, to
emergence of various options like the Self Help Group bank linkage programme
and the micro finance institutions (MFIs).
MFIs range from fair-sized NBFCs to
much smaller societies and trusts. The use of MFIs and other intermediaries as
business facilitators and business correspondents was also allowed by the
Reserve Bank in January 2006. And it has evolved into a vibrant industry
exhibiting a variety of business models.
Microfinance Institutions (MFIs) in India exist as NGOs
(registered as societies or trusts), Section 25 companies and Non-Banking
Financial Companies (NBFCs). Many microfinance institutions have recently
registered as NBFCs to take advantage of access to capital markets.
Micro finance institutions operating as NBFCs account for the great majority of
the microfinance market in India, with about 50 NBFCs responsible for 80
percent of all micro finance loans (by outstanding portfolio).
According to the Study Group on Indigenous Bankers (1971), a
moneylender lends his own funds, while an indigenous banker acts as a financial
intermediary by accepting deposits or making bank credit available. While
moneylenders do mainly cash transactions, indigenous bankers deal in short-term
credit instruments (hundis2) for financing the production and distribution of
goods and services (SGIB 1971).
The profit of indigenous bankers is based on the quick
turnover of capital. They prefer lending high amounts to a limited number of
clients and to leave the financing of agriculture to moneylenders. The
importance of informal finance has decreased during the post-colonial period.
The SGIB (1971: 113) estimates for 1968 a total of almost 34,000 moneylenders
and indigenous bankers, of which more than 19,000 are urban based.
Of late, Money
Lenders in India come under control of the Money Lenders Act, promulgated by
each of the different states. Compliance with the Act is rare however, and
majority of the money-lenders do not obtain such a license to operate.
NBFC Sector in India
Chapter III B of the Reserve Bank of India Act, 1934 (RBI
Act) was introduced in 1964 to regulate the deposit taking companies as the
first step in formalising the indigenous
Indian Banking space, and further, Non
Banking Companies (Reserve Bank) Directions, 1977, was notified to protect the interest of the depositors.
Simultaneously, section 58A of the Companies Act was introduced empowering
Central Government to regulate the acceptance and renewal of public deposits
and the Companies (Acceptance of Deposits) Rules, 1975 were framed , and
subsequent RBI Working Groups and Study Groups with recommendations and with
RBI Notifications and regulations, thus a new sector is being crystallised
as:- NBFCs.
NBFCs (Non-Banking Financial Companies) are different from
banks in that an NBFC cannot accept demand deposits, issue checks to customers,
or insure deposits through the Deposit Insurance and Credit Guarantee
Corporation (DICGC). In India, NBFCs comprises a multiplicity of institutions,
which are defined under Section 45 I(a) of the Reserve Bank of India Act,1934.
These are equipment-leasing companies (EL), hire purchase companies
(HP), investment companies, loan companies (LCs), mutual benefit financial
companies(MBFC), miscellaneous non-banking companies (MNBC), housing finance
companies (HFC), insurance companies (IC), stock broking companies (SBC), and
merchant banking companies (MBC). A non-banking company which conducts
primarily financial business and belongs to none of these categories is called
a Residuary Non-Banking Company (RNBC).
The regulatory responses on the part of RBI have also kept
pace with the evolution of this sector- Non-Banking Financial Sector(NBFC). In
particular, regulation has adequately addressed the issue of depositor
protection, a major concern of RBI. There has been a gradual, regulation
induced reduction in the number of deposit taking NBFCs, including Residuary
Non-Banking Finance Companies (RNBCs), from 1,429 in March 1998, to 311 in
March 2010. The deposits held by these companies (including RNBFCs) decreased
from Rs. 23,770 crore, comprising 52.3 percent of their total assets, to Rs.
17,273 crore, comprising 15.7 percent of their total assets. There are 12,371
registered NBFCs as of November 2012, of which, 12,104 non-deposit taking NBFCs
while 265 take deposits from retail investors.
RBI Report on 31st January 2012, states that the number of
NBFCs has decreased from 13,014 in FY06 to 12,409 in FY11 however the sector
has grown by 2.6 times between FY06 and FY11 at a CAGR of 21%. It accounted
for10.8% in terms of outstanding advances and 13% in terms of assets of the
banking system inFY06. This share has risen to 13.2% and 13.78% respectively in
FY11. In terms of deposits the share of public deposits held by NBFCs as
compared to deposit base of banks has decreased from 1.05% in FY06 to 0.22% in
FY11.Public deposits held by NBFCs have shown a falling trend, decreasing by
approximately 48% in the last 5 years, while owned funds (reserves &
surplus and capital deployed) have gone up by 195%. The outstanding advances
have grown approximately 3 times in the last 5 years to reach Rs.536,074 crores
in FY11. Banks exposure to NBFCs has increased from Rs.62,308 crore in FY06 to
Rs.183,839 crore in FY11, an increase of approximately 3 times growing at a
CAGR of 24% during the period FY06-FY11 and a 37% increase over FY10.
Convergence of NBFC with Banks
RBI policy guidelines from time to time has led to a
convergence of NBFCs to Banks; and NBFCs
that were earlier allowed to be converted into banks were M/s Kotak Mahindra
Finance Ltd and M/s 20th Century Finance Ltd. While Kotak Mahindra Bank has
diversified into various financial services, 20th Century became Centurion
Bank; it was taken over by a bunch of private equity investors and
eventually merged with HDFC Bank. Two of the other new licensees in the early
1990s—HDFC Bank and UTI Bank (renamed Axis Bank)—have become very successful
private banks. M/s Ashok Lyland Finance Ltd merger with the Indusind Bank was
the first Merger of an NBFC with a Bank.
The new RBI guidelines clearly eliminate chances of groups
engaged in broking and real-estate activities as contenders - it offers
adequate flexibility to RBI for 'choosing' the promoters of new banks. RBI has
also kept subjectivity in lots of cases (like diversified ownership,
professional management, feedback from regulators Tax, CBI, ED etc., coupled
with assessment of business plan with regard to financial inclusion); these
subjectivity will help RBI to keep final discretion in granting the licenses.
Key highlights of the draft include a minimum capital requirement of Rs 500
crore, a 49 percent cap on foreign shareholding and the barring of corporate
groups with 10 percent or more of their income or assets from/in the broking
and real estate businesses from applying for a bank licence. The guidelines
also state that a new bank has to be set up through a non-operative holding
company, which will not only hold the bank but also all other financial
services companies. If the promoter already has a non-banking finance company
(NBFC), that NBFC can either be converted into a bank or pass on all
banking-related activities to the new bank. However, NBFCs returns on assets
(RoA) and equities (RoE) will slide, as the returns of banks are much lower
than those of NBFCs. For instance, M&M Finance earns 4.5 percent on its
assets and about 24 percent on equity. The best private bank, in contrast,
earns just 1.6 percent on its assets and less than 20 percent on equity.
Implication of RBI working Group on Small NBFCs.
The RBI-constituted panel, headed by its former deputy
governor Usha Thorat, to tighten rules for NBFCs has proposed that these
companies should have minimum assets of Rs 25 crore. Thorat has also suggested
that their minimum equity capital be raised to 10% of risk-weighted assets from
7.5%.More than two-thirds of NBFCs face closure if the Usha Thorat panel
recommendation on minimum asset size is implemented by the Reserve Bank of
India, shutting a vital source of funding in many parts of the country. Nearly
9,000 companies lending to borrowers in small towns and villages that lack
banking facilities could be in danger of losing their licences as their asset
size is less than Rs 25 crore. Thus, it is expected 70% of NBFCs could go out
of business if the proposed requirement of Rs 25 crore of financial assets is
accepted. The moment the RBI implements the minimum requirement clause; these
companies may be covered by the various acts governing moneylenders that are
inimical to the corporate way of functioning; and there are 23 different money
lending Acts in India, the NBFCs to follow, eventually once it get deregistered
from RBI.
The Present Regulatory Architecture in Indian Financial
Services
India’s current regulatory architecture for the financial
sector is a maze (Mobis Philipose 2013). There are over 60 Acts with myriad
rules and regulations that govern the sector, some of which have been written
decades ago. In addition, many ad hoc changes have been made over time to these
regulations. As things stand, the Indian financial sector is suffering from
regulatory gaps, overlaps, inconsistencies and also provides opportunity for
regulatory arbitrage. Securities and Exchange Board of India’s (Sebi) extended
litigation against the Sahara group, and the recent investigations on alleged
money laundering by some banks using insurance products are good examples of
both regulatory gaps as well as opportunities for arbitrage.
Money Lending Acts in India
The nature of the money lending laws is regulatory, with
emphasis being on protecting the
Interests of the borrowers by providing definite upper
limits on rates of interest and curbing coercive Recovery practices. An examination of the money lending
legislations by RBI, in 22 States, shows that the provisions are generally
similar. The object of legislation pertaining to money lending is to regulate
and control the business of money lenders. The history and object of enacting
the money lending legislations can be inferred from the observations made by
some High Courts. Thus, in Sk. Abdul Sattar v. Sitaram Sah and Anr.31, AIR 1988
Pat 233; observations of Honourable Mr. Justice S.K. Jha ,the Bihar High
Court, observed as under:
"Before embarking upon this question, it is relevant to
state at the outset that the Act was brought on the Statute book to consolidate
and amend the law relating to regulation of money-lending transactions and to
grant relief to the debtors in the State of Bihar.
The majority of legislations relating to money lending were
passed by the various States of India
several decades ago. It is, therefore, pertinent to examine
whether the legislations are still relevant.
The Group recommends that the term “bank” may include all
banking companies, nationalised banks (corresponding new banks), State Bank of
India, its subsidiary banks, Regional Rural Banks , Co-operative bank also
being registered with and regulated by RBI. NBFCs should be exempt from the
money lending legislation. Similarly, lending transactions by registered
charitable societies and public trusts should also be exempted from the purview
of the legislations. The Group also recommends that the State Government should
be empowered to notify any other financial institution in consultation with the
Reserve Bank for exemption from the provisions of the legislation ( rbi on money
lending).
As of now, the NBFCs which is regulated by the RBI cannot face
overlapping regulation from the State law-Money Lending Acts, the Supreme Court
ruling Radhey Estate Developers vs Mehta Integrated Finance Co Ltd., a Division
Bench of Gujarat High Court (ruling dated 26th April 2011) ruled that the
Bombay Money Lenders Act, as applicable to the State of Gujarat, does not apply
to non-banking financial companies which are regulated by the RBI will operate only in respect of such NBFCs
which are registered with the RBI. There are tens of thousands of companies
that carry NBFC business, though without any registration. The Kerala High
court has in Link Hire-Purchase And Leasing Co. (Pvt.) Ltd. And Premier Kuries
And Loans (Private) Ltd. vs State Of Kerala And Ors. 103 Comp. Cas 941 (Ker)
held that the money lending laws of the State are applicable to a company even
if the company is a registered NBFC. However, the same was challenged by NBFCs
in Supreme Court, and is pending as a Civil Appeal for final verdict.
Thus the Technical Group feels that the above measures would
narrow down the scope of the legislation, allowing the administering
authorities to concentrate on the regulation of pure money lending transactions
by individuals and entities conducting business with a profit motive. ( rbi on
money lending). The State Government in consultation with the State Level
Bankers’ Committee (SLBC) could link the rate to a bench-mark with a maximum
mark up permitted over the bench mark to factor in other costs, ease of access,
doorstep delivery and reasonable margin.
NBFC Laws – Applicability of the Usurious Loans Act, 1918
& the Interest Act, 1978.
The Usurious Loans
Act, 1918 is also currently applicable to transactions relating to money
lending. The Usurious Loans Act, 1918 (ULA) was enacted with
the object of preventing the Civil Courts being used for the purpose of
enforcing harsh and unconscionable loans carrying interest at usurious rates.
The State Government has been empowered to exempt, by way of notification in
Official Gazette, any area, class of transactions or class
of persons from the applicability of ULA. ULA provides guidelines to the Court
for examining whether a particular rate of interest can be considered to be
excessive or not and also for considering whether a transaction is
substantially unfair or not. The ULA is applicable to all suits as mentioned
above irrespective of the parties involved in the disputes. Therefore, the Act
is also applicable to suits in which a moneylender is a party. (Section 1(3) of
the Usurious Loans Act, 1918). Even if there is no prohibition under ULA
against charging of compound interest, the Courts have a duty of examining the
transaction as a whole and ascertaining whether in a given case, the transaction
is unfair or the rate of interest is usurious.( *AIR 1982 Mad 296 (303)).
Though not a part of the overall body of laws relating to money lending, there
is one more Act, viz ,the Interest Act, 1978 which can also be applied by
Courts while granting interest in suits.
GOLD LOAN-NBFCs.
The RBI Working Group headed by KUB Rao also expressed
concern on some gold loan NBFCs which have been raising public deposits
surreptitiously through unincorporated bodies .There are interlink ages within
the gold loan NBFC segment in the form of gold loan NBFCs floating
unincorporated sister concerns to undertake financial activities, which are not
permitted by the financial regulator. Such activities primarily involve raising
public deposits and diverting these funds towards registered gold loan NBFC.
Raising public deposits by such illegitimate means can have implications for
public confidence in the concerned NBFCs and non-banking financial sector as a
whole.
KUB Rao panel, finding large numbers of complaints are
being received against the NBFCs, suggested a need for an ombudsman to hear the
grievances.
The Chit Fund Business
In the Chit Fund Business too there is multiple rules and
regulation , and different states with different enactments, and 'The Chit Funds Act 1982' by the Parliament
of Union Government is the Central Act. Most of the provisions of the Central
Act apply to the Chit funds run in different parts of India. However, the State
Acts may override certain provisions as deemed necessary.For Eg:- Kerala Chitties
Act, 1975, also imposes other stringent rules that have resulted in many
companies registering themselves outside the state (primarily in Jammu and
Kashmir where the Central Act does not apply). One should also note that in
states which do not enact a State Chit Fund Act, the Central Act will
automatically prevail.
Co-ordination among Financial Markets
Financial Stability and Development Council ,FSDC, the apex
level regulatory body , was formed to bring greater coordination among
financial market regulators. The council is headed by the finance minister and
has the Reserve Bank of India (RBI) governor and chairpersons of the Securities
and Exchange Board of India, Insurance Regulatory and Development Authority and
Pension Fund Regulatory and Development Authority as other members along with
finance ministry officials.
FSDC envisages to strengthen and institutionalise the
mechanism of maintaining financial stability, financial sector development,
inter-regulatory coordination along with monitoring macro-prudential
regulation of economy, by maintaining the autonomy of Institutions
like RBI , SEBI , IRDA & PFRDA e.t.c..
On tap RBI approvals for New Banks
RBI approval for IDFC and Bandhan Financial Services Private
Ltd to set up banks, from a field of 25 aspirants for licenses opened the
convergence model from Non- Banking to Banking. Incidentally, both IDFC and
Bandhan are non-banking finance companies. While Mumbai-based IDFC is
classified as an infrastructure finance company, Kolkata-based Bandhan is a
microfinance institution. Going forward, the RBI intends to use the learning
from this exercise to revise guidelines appropriately and give licences more
regularly, that is, virtually “on tap”. It will also frame categories of
differentiated bank licences, building on its prior discussion paper, and
allowing for a wider pool of entrants into the banking sector, especially of
Non-Banking players belonging to Shadow Banking.
The Bandhan Effect.
The Bengal-based microfinance institution has grown manifold
since its inception in 2001. The Bandhan Micro Finance Institution roots lie in
a society named Bandhan Konnagar, which began lending in 2002. In May 2006,
Bandhan acquired a non-banking finance company, Ganga Niryat Pvt Ltd, which was
incorporated in 1995, and rechristened it Bandhan Financial Services Private
Limited. This was converted into a non-banking finance company (microfinance
institution) in September 2013.
Regulations for Convergence
Similar to Banking Ombudsman, there has to be a separate
Ombudsman type mechanism for multi-legislated Money Lending & Chit Funds /
Sector Specific NBFCs like Gold Loan e.t.c., and a separate regulator for Chit
Funds and NBFCs left out form the RBI Registrations and a clear legislations in
line with RBI Study group as to the applicability of Money Lending legislations
limited to Individuals , with clear rules and regulations for unregistered MFIs
/ SHGs so as to bring all unregistered entities or (Unincorporated bodies
(UIBs) .
In terms of provision
of section 45S of the RBI Act, UIBs are prohibited from accepting any deposit.
The state government has to play a proactive role in arresting the illegal
activities of such entities to protect interests of depositors / investors.
UIBs do not come under the regulatory domain of RBI. Whenever RBI receives any
complaints against UIBs, it immediately forwards the same to the state
government police agencies (Economic Offences Wing (EOW)).
The Bandhan Effect with RBI Model of “on tap” for new
Banking Licences along with regulatory co-ordination by Regulators are expected
to pave the way for convergence of the informal credit intermediaries to formal
Banking Sector in Indian Financial Service Sector.
