Keep Eye On Shadow Banking

BS 27 June 2014

In India, shadow banking entities essentially refer to the large number of unregulated companies that act as financial intermediaries, providing credit and generating liquidity in the system

 

The Reserve Bank of India (RBI) on Thursday said there was a need to monitor "shadow banking" entities, which were perceived to be regulated by the central bank, albeit inaccurately, to eliminate ambiguities related to legal, regulatory and administrative aspects of their functioning.

In India, shadow banking entities essentially refer to the large number of unregulated companies that act as financial intermediaries providing credit and generating liquidity in the system. For instance, companies engaged in multi-level marketing, offering prize chits and money circulation schemes are currently not regulated by RBI.

"(The shadow banking sector) raises concern partly because of the public perception that they are regulated," the central bank said in its financial stability report released on Thursday.

At a time when some developed economies have initiated efforts to mitigate systemic risks posed by shadow banking activities, India has witnessed a a significant increase in the exposure of its banks to shadow banking entities.

"The motivation for regulatory reforms in the shadow banking space in developed economies, especially in the US, emanated from certain dilemmas that, on the one hand, there was a need to de-risk the overgrown complex banking industry, which inevitably needs the presence of shadow banking entities to absorb those risks and the concerns over the role of shadow banking entities in consummating the financial crisis, on the other," RBI said.

The banking regulator, however, admitted that in developing markets such as India these concerns might not be entirely valid because of the low penetration of banking services, much less complex financial markets and level of regulatory oversight exercised over shadow banking activities. In fact, some shadow banking entities have been playing an important role in supporting efforts towards financial inclusion.

But with relatively lower levels of financial awareness and the misconception that all financial activities come under some regulatory framework, shadow banking entities in the country may assume systemic importance.

Hence, the central bank feels there is a need for clarity in the regulatory framework for shadow banking entities in India. "There is a need to assess the collective size and profile of activities of the large number of non-bank financial entities functioning in the organised as well as the unorganised sector (including unincorporated entities which are outside the purview of the regulatory perimeter)," RBI said.

The banking regulator is in the process of reviewing the regulatory framework for non-banking financial companies (NBFCs), based on the recent developments in the sector and also recommendations made by the Nachiket Mor committee.

"The proposed review will cover the legislative framework of the NBFC sector, asset classification and provisioning norms for NBFCs vis-a-vis that of banks - (including the need for raising tier-I capital requirement for NBFCs), corporate governance guidelines including 'fit and proper' criteria for their directors, regulation of deposit acceptance activity, consumer protection measures, present classification scheme of NBFCs and activity of lending against shares by NBFCs," RBI said.

Better days ahead for economy

BS 27 June 2014

But says supply-side concerns need to be addressed; bank capital also a challenge

The worst might be over for the economy following the formation of a stable government, though supply-side issues needed to be solved to help monetary policy bring down inflation, the Reserve Bank of India (RBI) said in its bi-yearlyFinancial Stability Report on Thursday.

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The overall tone of the report reflected optimism generated by the thumping majority scored by the Bharatiya Janata Party in the recently-concluded general elections. "Going forward, with the formation of a stable government, the prospects of recovery appear bright," the RBI said.

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The central bank drew comfort from reduction in both fiscal and current account deficits and moderation of consumer price index (CPI) -based inflation.
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The report also said the general risks facing the Indian economy were expected to come down. However, the supply-side constraints needed to be addressed to complement the RBI's efforts to contain inflation.
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"Markets expect more decisiveness in government policy formulation, as well as greater efficiency in implementation," RBI Governor Raghuram Rajan said in the foreword to the report.

"Further progress on fiscal consolidation, a predictable tax & policy regime and low and stable inflation rates will be the key anchors in promoting India's macroeconomic and financial stability," Rajan added.

RBI said easing of domestic supply bottlenecks and the progress on implementation of stalled projects that had already been cleared should further improve the growth outlook.
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The economic prospects are looking bright but the banking sector continues to face headwinds, though there was a marginal improvement in asset quality in the second half of last financial year.

The central bank added while the Indian financial sector remained stable, public-sector banks continued to face challenges in terms of asset quality, profitability, capital, and, most importantly, governance and management processes.

According to RBI data, the share of both gross and net non-performing assets in total assets declined as of March end, compared with that towards the end of September. While gross NPA's share in total declined 20 basis points to four per cent, net NPA's declined 10 bps to 2.2 per cent during the period under review. Sale of NPAs to asset reconstruction companies in March was cited as a reason for a decline, though lower slippages and higher recovery was also evident.

The report showed public-sector banks' profitability was under significant pressure as their net profit contracted 30.7 per cent during the six-month period, compared to an increase of 19.7 per cent among new private banks. The poor show by public-sector banks was mainly due to lower income and higher provisioning requirements.

So far as the capital adequacy ratio is concerned, while there was a marginal improvement during the six-month period on the back of a sharp contraction in risk-weighted assets (which fell to 12.6 per cent in March from 24.7 per cent), public-sector banks stare at raising enormous capital over the next five years.
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The report estimates that public-sector banks will require at least Rs 4.15 lakh crore of additional capital - Rs 1.43 lakh crore of that as equity capital - till 2018 for implementation of Basel-III norms.

The government's contribution to public-sector banks' equity capital to maintain the existing level of its stake is estimated at Rs 90,000 crore. It will be a challenge for the government, which has to be mindful of fiscal consolidation too, to infuse this large a sum.

The report said high inflation and the consequent low real rate of return on financial assets might force savers to assume excessive risks in their search for better returns.
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The share of households' financial savings (which includes bank deposits) in gross domestic product (GDP) has been declining. But expenditure on valuables (including gold) has risen over the past few years - though it declined in 2013-14. 

Household financial savings' contribution to GDP declined from about 12 per cent in 2007-08 to about seven per cent in 2013-14. Expenditure on valuables rose from about seven per cent to about 10 per cent. "This trend reflects financial disintermediation, with households switching away from financial savings to valuables, mainly gold," the report said.

Further, gross capital formation (GCF) declined for a second straight year in 2012-13. This decline in GCF was led by the private corporate sector, thereby adversely impacting the growth prospects of the economy.

The central bank also emphasised the need for developing the corporate bond market and said removing hindrances in this market should be "top policy priorities".

It added the central bank might choose to relax the rules for mandatory minimum holding in bonds - referred to as statutory liquidity ratio - and the proportion of bonds which need not be marked to market gradually, as banks progressively implemented the Basel III liquidity coverage rules

RBI Tightens Prudential Norms

IE 26 June 2014

The Reserve Bank of India on Thursday indicated that big banks — to be classified as domestic systemically important banks (D-SIBs) — will be asked to bring more capital and brought under stringent supervision from August 2015.

The RBI’s bi-annual Financial Stability Report (FSR) also highlighted the need to assess the collective size and profile of activities of the large number of non-bank financial entities functioning in the organised as well as the unorganised sector, including unincorporated entities which are outside the purview of the regulatory perimeter, or collectively called shadow banking.

Based on their systemic importance scores, banks will be plotted into different buckets and D-SIBs will be required to have an additional common equity Tier 1 capital requirement ranging from 0.20 per cent to 0.80 per cent of the risk-weighted assets.

“D-SIBs will also be subjected to differentiated supervisory requirements and higher intensity of supervision based on the risks that they pose to the financial system. The names of the banks classified as D-SIBs will be disclosed in August every year starting from 2015,” it said.

The RBI said a preliminary study carried out by the Shadow Banking Implementation Group (SBIG) comprising of members from all financial sector regulators, concluded that there was a high degree of heterogeneity in business models and risk profiles across various non-bank financial entities in the organised (including the entities not ‘registered’ with any of the regulators) as well as the unorganised sector.

Apart from such NBFCs, SBIG has also identified ‘exempted’ provident funds, unregulated chit funds, co-operative and credit societies and primary agricultural credit societies as groups of institutions that need a greater degree of oversight.

“Also, government-owned entities discharging the functions as special NBFCs which are exempt, by statute, from adherence to prudential regulations and given their systemic significance, are an area of concern. Certain other entities such as special purpose vehicles (SPVs) are not regulated and can cause overleveraging and risks to the financial system,” the FSR said.

While the FSR mentioned the formation of a stable government at the Centre has ameliorated political risk and has led to expectations of better policy coordination and implementation, it also said the risks to the banking sector have increased with concerns over liquidity and profitability continuing.

Despite marginal improvements in the soundness and asset quality, the level of gross non-performing advances as percentage of total gross advances of public sector banks was significantly higher as compared to the other bank groups, it said.

In his foreword to the report, RBI Governor Raghuram Rajan said, “India’s financial system remains stable, although the public sector banks face challenges in coming quarters in terms of their capital needs, asset quality, profitability and more importantly, their governance and management processes.”

While India remains committed to implement global regulatory reforms, priorities may differ as the Indian financial system faces a different set of challenges as compared to those jurisdictions which faced financial / banking crises, he said. While “the country has chosen a politically stable government”, Rajan said markets expect more decisiveness in policy formulation.