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Prologue
Securitization
What happened in Sub-prime crisis?
Shadow Banking
1. Shadow Banks: Why bad?
2. Shadow Banking in India?
3. Should India be worried?
4. Gold Loan Companies as Shadow Banks?
5. RBIs safeguards on Gold loan NBFC
5. Wholesale Bank?
1. Wholesale Investment Bank vs Wholesale Consumer Bank?
2. but Why Wholesale Banks?
3. Benefits of Wholesale Banks?
6. Mock Questions
Prologue
Under [Banking] Nachiket Committee article-series, so far weve seen following
1. What is financial inclusion, steps taken by RBI and Government to achieve it.
2. Nachi gave six point vision to achieve financial inclusion. Under that, Universal Bank account for
everyone. Access to banking within 15 minutes of walking distance.
3. Priority sector lending: meaning, benefits, constrains and Nachikets recommendation for 50% PSL
target and 0% SLR.
If youve not read those articles, go to Mrunal.org/economy.
Securitization
As such very technical topic and not important for exam but basic understanding necessary before
dwelling into Shadow Banking, Whole-sale banking. So, first lets construct a technically-not-so-correct
model:
A retail Bank has given home loans worth total 100 lakhs to 50 families @10% interest rate. (if
anyone defaults, bank snatch their house.)
An investment banker, Hrithik Roshan, buys these loan-files from the normal bank.
Hrithik makes a new company/entity, backed by those home loan files worth Rs.100 crores.
Then he breaks down those 100 lakhs into (10 lakh bonds x worth Rs. 10 each) and promise to pay
8% interest rate.
Aam Aadmi/retail investors/Mutual funds/insurance companies etc. buy these bonds.
Securities =some piece of paper that promises to some money to someone.
Shares, bonds, IPOs, Debentures these are all examples of securities.
So, What did the investment banker do in above example? He turned those mortgages (homes
loan files) into securities. [and made some profit in between].
This is called securitization.
Is it good or is it bad?
Good for banks because they can gather some new cash, look for new clients. (rather than waiting
for EMI payments for 20-30 years.)
Good for investors, because they can earn interest by buying those bonds.
Bad? Yes, when the game is played without good faith- as it happened in Sub-prime crisis.
Shadow Banking
1. Shadow Banks = organizations that function like banks but outside the banking regulation.
American examples- hedge funds, securitization companies, Special Investment Vehicles (SIV),
Money Market Funds (MMFs) etc.
2. This term came after subprime crisis in USA, 2007.
3. Shadow banks helped creating that asset bubble. But one day, home loan borrowers defaulted and
the bubble collapsed =>crisis.
4. Shadow banks have significant presence in Netherland, Hong Kong, USA, EU= they continue to
remain vulnerable to such crisis even in future.
Shadow Banks: Why good?
They provide quick source of loan/credit/finance/liquidity.
Function
example
Regulated
under
Insurance
companies
IRDA
Housing Finance
Companies
Stock Broker
National
DHFL, Muthoot Housing finance
housing Bank
etc.
(NHB)
Canara Bank, Andhra Bank (and
many other banks- they take
SEBI
separate license to operate as a
Merchant Bank)
1. Indiabulls
2. Sherkhan
SEBI
companies
Venture Capital
They finance start-up companies via
Fund Companies equity. (=shares, partnership)
Nidhi
They borrow money from members,
Companies(mutual
lend it among the members.
benefit funds)
Chit Funds
3. Reliance Money
between.
IFCI, IDG
SEBI
Department
of Company
affairs
Some of these NBFCs do form one type of Shadow banking in India, because theyre outside the
traditional regulatory rules for Banks, dont have SLR-CRR emergency backup, still dwelling into depositsloan-credit-finance type work.
Among all these, Chit fund is the biggest headache. Why?
Constitution of India=>7th Sch.=> union list=> banking, post office savings, corporation, insurance,
stock exchange, future market fall here.
Hence union government make can make laws to setup All India regulators RBI for bank, SEBI for
securities and IRDA for Insurance.
But as per SC verdict, Chit fund=contract = falls under concurrent list. = both union and state can
make law. Hence chit funds government by their respective state laws. RBI only provides overall
guidelines. SEBI doesnt watch. thats how Saradha chit fund managed to evade regulatory
oversight and duped crores of rupees.
3. These Gold loan NBFCs are regulated by RBI but they dont fall under traditional bank rules about
SLR, CRR norms.
4. So, Do they pose a systematic challenge like American Shadow Banks?
lets take an example:
Jan 2014: 10 gm gold =30,000 rupees. I deposit it a gold loan company, they give me Rs. 30000
(=loan to value ratio of 100%; if they gave me only Rs.15k, the loan to value ratio=50%).
Ive to repay this loan, with 25% interest by Dec 2014.
December 2014: price of gold still remains in the 29-30k region. Then ill not bother repaying the
loan (because Ive to give Rs.7500 interest). So, let them have the gold. I dont care much.
if large number of borrowers start doing ^this, system will collapse. Why? Because Gold Loan
company doesnt print currency notes at its office. They also have to arrange money from market
(mostly from banks and debentures sold to aam-admi/retail investors).
So, if gold loan company collapses, then negative ripples even in other sectors of economy.
Wholesale Bank?
So far we know What is Shadow banking, how it can be a threat to economy.
Right now Desi-NBFC sector is still small (compared to Banks), but with time, some of these NBFCs
will grow extremely large.
Then, itll not be our best interest to let them continue as NBFC (Because theyre not covered
under CRR-SLR emergency backup.)
Therefore, Nachiket Committee recommends a new type of bank called Wholesale bank. So, large
NBFC could be allowed to transform into Wholesale banks and fall under full supervision by RBI.
Please note: Nachi also recommended Payment banks. Make sure youve read that topic first.
Click me
Sch.Commercial
Bank (SBI, PNB, Wholesale bank
ICICI)
Has to get
license under
Yes
Banking
regulation Act?
Ofcourse yes.
Can accept
Hence also
deposits from
called Retail
aam aadmi?
banks.
Access to
payment
system (can
Yes
give cheque
book?)
Payment Bank
NBFC
yes
Nope
Yes
Yes
Yes
No.
Yes
CRR?
Yes
yes
SLR?
Yes
Yes
Entry capital
requirement?
500 Crores.
50 crores.
50 crores
5 cr for Microfinane
company. 2 cr for
others.
Yes.
No.
PSL
yes
Nachi did not give
specific targets. But
they can invest in
SLR-securities.
Yes
Nope
Only for NBFC-D
SARFAESI
powers.*
Yes
Yes
*SARFAESI powers= If you default on loan, theyll take away your mortgaged property. You cannot get stay
order from civil court. Youve to approach DRT (debt recovery tribunals) to get stay order, but they usually
rule in favor of banks.
Mohan
1. What is securitization, how it helps transforming mortgages into securities. And how it can
be a threat, if misused.
2. What is shadow bank? How does it pose danger to Economy?
3. That youve recommended new type of banks called Wholesale Banks.
but what is the purpose of creating this wholesale bank? What exactly will they do?
1. We already have investment bankers in India- performing almost the similar functions like these
wholesale banks. (Standard Chartered, Kotak Mahindra capital, Citigroup, Morgan Stanley etc.)
2. But theyve not caused any risks in India because our regulators (RBI, SEBI) are more vigilant and
strict than American counterparts.
Besides, if we assume only the worst case scenario, progress cannot be made. And The advantages of
wholesale bank, outweigh its risks. Observe:
Mock Questions
1. Correct statements
A. All NBFCs are regulated by SEBI
B. All NBFCs are regulated by RBI
C. Both A and B
D. Neither A nor B
2. Which among the following is/are covered under the Concurrent list in our Constitution?
A. Banking, Bankruptcy, Contracts
B. Contracts, Corporations, Trusts
C. Trusts, Contracts, Bankruptcy
D. None of above.
3. What do you understand by the term Shadow Banking?
A. A system wherein banks use technical loopholes to open more branches and expand
operations beyond what is permitted by RBI.
B. A system wherein scheduled commercial banks use technical loopholes to partially evade
their true liabilities under CRR, SLR and PSL.
C. A system wherein financial entities undertake activities akin to banks while remaining
outside the traditional regulatory regime which are otherwise applicable to banks.
D. None of above.
4. Recently, Nachiket Committee has recommended Securitization of PSL loans. What do you
understand by the term Securitization?
A. It is a process under which banks get insurance cover for their loans under PSL targets,
from General insurance companies.
B. It is a process under which the mortgages issued by banks and other lenders are converting
them into securities that can be sold to investors.
C. It is a process by which a mortgaged loan asset can be converted to cash without losing
value.
D. None of above.
5. Which of the following factor(s) make India less vulnerable to the risks from shadow banking?
A. RBI has specifically prohibited shadow bank entities from opening branches in India.
B. Under SARFAESI act, Government has specifically prohibited shadow bank entities from
giving loans to people.
C. Both A and B
D. Neither A nor B
6. Recently, Nachiket Committee has proposed a new model of banks, called Wholesale banks. Find
correct statement about them
A. Only Scheduled Commercial banks can setup such banks through subsidiary model.
B. Theyll enjoy the rights and privileges under SARFAESI Act.
C. Theyll have higher entry-capital requirements than commercial banks.
D. None of Above
7. (A) Chit fund companies are regulated by State laws. (R) The subject of Chit fund falls under State
list in 7th Schedule of Constitution of India.
A. Both the statements are individually true and Statement R is the correct explanation of
Statement A
B. Both the statements are individually true but Statement R is not the correct explanation of
Statement A
C. Statement A is true but Statement R is false
D. Statement A is false but Statement R is true
Q8. All NBFCs are exempted from
1. Maintenance of CRR
2. Maintenance of SLR
3. Priority sector lending targets.
Answer choices
A.
B.
C.
D.
only 1 and 2
only 2 and 3
only 1 and 3
all 1, 2 and 3.
Q9. Who among the following is/are not required to maintain a Cash Reserve Ratio (CRR)?
1. Shadow Banking entity
2. Merchant Banking entity
3. Housing Finance Company
Answer Choice
A.
B.
C.
D.
only 3
only 1 and 3
only 1 and 2
All 1, 2 and 3
Q10. Who among the following is/are fall under SEBIs direct regulatory watch?
1.
2.
3.
4.
Nidhi Company
Chit funds
Housing Finance Company
Merchant Banking company
Answer Choice
1.
2.
3.
4.
only 1 and 2
only 3 and 4
only 1, 3 and 4
all of them
Descriptive
1. Define Shadow Banks. Assess the vulnerability of Indian financial sector from the threat of Shadow
Banking. (10m| 200 words)
2. Examine the need for a super-regulator over the other regulators in banking-finance-insurance
sector with special reference to shadow banks. (10m| 200 words)
3. List the salient features and functions of these wholesale banks envisioned by Nachiket
Committee. (10m| 200 words)
4. Discuss recent initiatives by RBI to preserve stability in Gold Loan sector. (5m | 100 words)
Interview
1. Do you know the difference between:
A. Merchant banking vs corporate banking?
B. Wholesale banking vs retail banking?
C. Investment bank vs commercial bank?
2. Whenever someone raises even a hint of sub-prime like crisis in India or shadow banking in India,
the RBI-apologists defend saying our fundamentals are strong, our regulatory regime is strong. If
that is the case, why do Public sector banks have large NPAs?
3. And dont you think they pose danger of sub-prime crisis in India?
4. Some economists suggest government of India should completely disinvest from public sector
banks. Given the threat of Shadow banking and sub-prime crisis on side versus the inefficiencyunionism-strikes, BASEL norms and NPAs on the other side, where do you stand on this issue?
5. Do you think Contract as a subject should be shifted to Union list, to prevent any more chit fund
scams?Yes/No and Why?
Hints for MCQs
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4.
5.
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7.
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9.
10.
Visit Mrunal.org/Economy For more on Money, Banking, Finance, Taxation and Economy.