Context: Shadow banks must review how they lend money as the Reserve Bank of India (RBI) strengthens norms and squeezes their credit lines.

RBI’s Report Highlights Risks in NBFCs

• Recently, the RBI increased the risk weights for Non-bank financial companies (NBFCs) (and Banks)  by 25 percentage points to 125% on retail loans.
  •  Risk Weights: Banks need to set aside capital for every loan.
• The RBI’s ‘Financial Stability Report‘ of June 2023 drew attention to NBFCs’ personal loan growth: It rose year-on-year by 31.3 percent while the industry grew slower by 12.7 percent hinting towards issue asset quality.

What is Shadow Banking?

• The shadow banking system consists of lenders, brokers, and other credit intermediaries outside traditional regulated banking.

• Shadow banking is generally unregulated and not subject to the same risk, liquidity, and capital restrictions as traditional banks.
• 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.
• In India, the crisis of the NBFCs that was triggered by the liquidity problems of IL&FS in 2018, has brought back attention to the shadow banking sector.

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Source: Business Standard