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Important Facts For Prelims

Shadow Banking

  • 29 Nov 2019
  • 2 min read

Shadow banking is a term used to describe bank-like activities (mainly lending) that take place outside the traditional banking sector.

  • It is also referred as non-bank financial intermediation or market-based finance.
  • Generally, it is not regulated in the same way as traditional bank lending.
  • 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 generate liquidity in the system.
    • However, the 2008 financial crisis has shown that shadow banking can be a source of systemic risk to the banking system. The risks can be transmitted directly and through the interconnectedness of partially-regulated entities with the banking system.
    • After the financial crisis, central banks including that of USA, Britain and the European Union (EU) have introduced many strong measures to control shadow banking.
  • In India, the crisis of the NBFCs that was triggered by the liquidity problems of IL&FS in 2018, has brought back the attention to shadow banking sector.

Source: BS

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