The

Growth of a Shadow Banking System in

Emerging Markets: Evidence from India

Viral V. Acharya
NYU, Stern NBER CEPR

Hemal Khandwala
Center for Advanced Financial Research and Learning

T. Sabri nc
Center for Advanced Financial Research and Learning
 ObjecQve of the Study

Our goal is to invesQgate the rapid growth of the non-deposit

taking nonbank nance corporaQons (NBFCs) in India to
understand

qIncenQves underlying the formaQon of shadow banking
insQtuQons, if any.

qLinkages between banking sector and NBFCs.

qHow the nature of the banking sector (state-owned versus

private banks) aects the growth and constraints on NBFCs.

 Summary of Results
q Bank lending to the non-deposit taking NBFCs

qforms a signicant proporQon of these NBFCs liabiliQes

quctuates in line with bank allocaQon to priority lending sectors
qappears to decrease as the banks expand in rural areas relaQve to
urban areas

q However, bank lending to these NBFCs is virtually non-existent for the
largest state-owned bank, State Bank of India (SBI) and its aliates
which have strong rural branching.

q These bank-NBFC linkages are present for those NBFCs that do loans or
asset nancing and not for investment companies, and also aect the
credit growth of these NBFCs.

q StarQng with the nancial crisis of Fall 2008, bank lending to these NBFCs
experienced a permanent contracQon that is related to the shi` of term
deposits towards SBI Group.


3



 What is Shadow Banking?
Shadow Banking is an evolving concept:

2007/McCulley: Shadow banking is the whole alphabet soup of levered up

nonbank investment conduits, vehicles, and structures.

2010/Acharya and nc: A shadow bank is a nonbank nancial ins<tu<on that

behaves like a bank, borrows short-term in rollover debt markets, leverages itself
signicantly, and lends and invests in longer-term in illiquid assets. Unlike banks,
however, the shadow banks are much less regulated.

2010/Adrian et al: Shadow banks are nancial intermediaries that conduct

maturity, credit, and liquidity transforma<on without explicit access to central
bank liquidity or public sector credit guarantees.

2012/Ghosh et al: Shadow banking comprises a set of ac<vi<es, markets,

contracts, and ins<tu<ons that operate par<ally (or fully) outside the tradi<onal
commercial banking sector, and, as such, are either lightly regulated or not
regulated at all. The dis<nguishing feature of shadow banking is that it
decomposes the process of credit intermedia<on into a sequence of discrete
opera<ons. A shadow banking system can be composed of a single en<ty that
intermediates between end-suppliers and end-borrowers of funds, or it could
involve mul<ple en<<es forming a chain.
4


 What is Shadow Banking?
Key points:

q Shadow banking system is typically highly levered. Further, while its assets
are risky and illiquid, its liabiliQes are prone to bank runs.

q Any shadow banking system conducts maturity, credit and liquidity

transformaQon outside the tradiQonal banking system. Thus, not only it
may be less regulated than the tradiQonal banking system or not
regulated at all, but also there is no explicit access to central bank liquidity
or public sector credit guarantees.

q Since any shadow banking system decomposes the process of credit

intermediaQon into a sequence of discrete operaQons, it can be a
collecQon not only of single nancial enQQes acQng independently, but
also of (and usually is) networks of mulQple nancial enQQes acQng
together or both: banks, formal and informal nonbank nancial
insQtuQons, and even credit raQng agencies, regulators and governments.
5

 Banks of India
Regulator: Reserve Bank of India

Unscheduled Banks
and
CooperaQve Credit InsQtuQons

Scheduled Banks

Commercial Banks CooperaQve Banks

Public Banks Private Banks Foreign Banks (36) Urban CooperaQve Banks

State Bank of India and

Old Private Banks (14)
Associate Banks (6) State CooperaQve Banks

NaQonalized Banks (20) New Private Banks (7)

Regional Rural Banks (82)

6
 Reserve Bank of India Regulated
NBFCs

Tightly Monitored Loosely Monitored

Deposit taking Non-deposit Taking Systemically Important

All other NBFCs
NBFC-D NBFC-ND-SI

Asset Finance
Company Asset Finance
Company

Loan Company Loan Company

Investment Company
Investment Company

Core Investment
Residual NBFCs
Company

Infrastructure Finance
Company

7
 ClassicaQon of NBFCs - AcQvity Based
qAsset Finance Company is a company:
qcarrying on as its principal business the nancing physical assets supporQng
producQve/economic acQvity: autos, tractors, material handling equipments,
etc.
qLoan Company is a company:
qcarrying on as its principal business the providing of nance whether by
making loans or advances or otherwise for any acQvity other than its own.
qInvestment Company is a company:
qcarrying on as its principal business the acquisiQon of securiQes.
qCore Investment Company is an investment company whose:
q90% of Net Assets in equity shares, preferred shares, bonds or loans of a
group of companies or
q60% of Net Assets in equity shares of a group of companies.
qInfrastructure Finance Company is a company which:
qdeploys at least 75 per cent of its total assets in infrastructure loans.
8
ClassicaQon of NBFCs - OrganizaQon Based
qStandalone NBFCs;
qBank and Financial InsNtuNon Sponsored NBFCs:
qaccording to the RBI, there are 28 currently:
q18 sponsored by foreign banks and nancial insQtuQons;
q10 sponsored by Indian banks.
qCapNve NBFCs:
qset up to put the parent company's products within the reach of
consumers and to ensure that the company has a steady pool of buyers;
qany major challenges confronQng the parent could threaten the
operaQons and asset values of the capQve NBFC.
qMulNple NBFCs:
qcompanies which have mulQple NBFCs within their group;
qexample: Shriram Group;
qtheir argument is that operaQonal eciencies arising out of specializaQon,
dynasQc reasons, tax planning are some of the reasons for mulQple
NBFCs.
9
From Deposit-taking to Non-deposit NBFCs

qSince RBI introduced prudenQal norms in 1998, the

number and share of deposit-taking NBFCs has been
shrinking

qThe RBI introducQon of non-deposit taking systemically
important (SI) NBFCs in 2006 has been coincident with
signicant growth in this newer class of NBFCs

qAs a combinaQon of these two eects, the NBFC share of

deposits has been shrinking steadily

10
Comparison between NBFC and Bank Sectors
Trillions of Rupees

FY06 FY10 FY11

Number of NBFCs 13,014 12,630 12,409
Bank Credit of all Scheduled Banks 15.728 33.377 40.608
NBFC Credit as percentage of Bank Credit 10.77% 12.57% 13.20%
Assets of all Scheduled Banks 25.315 52.58 61.47
NBFC Assets as percentage of Bank Assets 13.06% 13.33% 13.78%
Bank Deposits of all Scheduled Banks 21.858 46.352 53.552
NBFC Public Deposits as percentage of Bank Deposits 1.05% 0.37% 0.22%

NBFCs include NBFC-D, NBFC-ND-SI and RNBCs

Scheduled Banks include Commercial Banks and CooperaQve Banks

11
 Growth of the NBFC Sector

800
16000 NBFC-D NBFC-ND-SI
700
14000
600
12000
500
10000

8000 400

6000 300

4000 200

2000 100

0 0
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011

1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Number of All NBFCs Number of NBFC-Ds and NBFC-ND-SIs

12
 Growth of the NBFC Sector

12.0
NBFC-D NBFC-ND-SI NBFC-D NBFC-ND-SI
7.0
10.0
6.0

5.0 8.0

4.0
6.0
3.0
4.0
2.0
2.0
1.0

0.0 0.0
2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011

Assets in Trillions of Rupees Assets as percentage of Assets of Banks

13
Consolidated Balance Sheet of NBFCs
Trillions of Rupees

14
NBFCs include NBFC-D, NBFC-ND-SI and RNBCs
 Leverage of the NBFCs: Borrowings/Total Assets
Bank & FI loans as large or larger than Debentures

2007 2008 2009 2010 2011 2007 2008 2009 2010 2011

80% 70%

70% 60%
60%
50%
50%
40%
40%
30%
30%

20% 20%

10% 10%

0% 0%
Bank&FI Loans Debentures Other Total CP Bank&FI Debentures Other Total
Loans
NBFC-D NBFC-ND-SI

15
 Given this moQvaQon, the quesQons we ask are:

1. What role does lending to NBFCs play for banks?

q Given the non-urban focus of NBFCs, is it related to bank lending to
priority sector and their ability to reach out non-urban areas?
q Which type of banks (state, private, foreign) lend to NBFCs?

2. What aects the ability of banks to lend to NBFCs?

q Is it aected by stability of bank deposits?
q In turn, does bank lending aect NBFC credit growth?

3. How did the deposit shi` in the crisis of 2008 aect NBFCs?
q In parQcular, did the shi` to banks with stronger guarantees (SBI
group) constrain the NBFC growth?

16

 We use coarser NBFC and Bank Group types

1. NBFC types:
qInvestment Companies (borrow litle from Banks and serve as
placebo);
qFinance Companies (larger in assets, borrow more from Banks & FI).

2. Bank group types:
qThe SBI Group;
qOther Banks Group;
qNaQonalized Banks;
qNew Private Banks;
qOld Private Banks;
qForeign Banks.

17
Bank Groups by Assets (Trillions of rupees)

18
Credit Growth of Investment vs Finance NBFCs

19
Bank & FI Loans to Investment vs Finance NBFCs

20
 Five Datasets (June qtr 2006 June qtr 2011)
q NBFC-level balance sheet and non-performing asset data on
systemically important non-deposit taking NBFCs

q Bank group-level balance sheet data on bank groups

q Bank group-level priority sector lending data on bank groups

q Bank group-level bank branch data on bank groups

q Economic data on Indian 3 month and 10 year yields, gross

domesQc product and wholesale price index.

q Sample inclusion criteria yield an imbalanced panel data set of 257

NBFCs and 2374 NBFC-quarters from an iniQal imbalanced panel
data set of 383 NBFCs and 3629 NBFC-quarters

21

 Regional DistribuQon of the NBFCs in the
Dataset

PANEL&A:&Number&of&NBFCs&
&& IC& FC& TOTAL&
EAST& 17& (6.6%)& 10& (3.9%)& 27& (10.5%)&
NORTH& 25& (9.8%)& 38& (14.8%)& 63& (24.6%)&
!
SOUTH& 8& (3.1%)& 33& (12.9%)& 41& (16.0%)&
WEST& 82& (32.0%)& 43& (16.8%)& 125& (48.8%)&
TOTAL& 132& (51.6%)& 124& (48.4%)& 256& (100.0%)&
!

22
 SpecicaQon I

q yit is the NBFC specic dependent variable for the ith NBFC in the tth
quarter
q ICi, FCi and Rki, k=1,2,3,4 are the respecQve Investment Company,
Financing Company and Region indicators for the ith NBFC
q zt is the vector consisQng of the CRISIS dummy and bank group-wise
variables,
q xit is the vector control variables consisQng of NBFC specic
explanatory and economic for the ith NBFC in the tth quarter and
q eit is the error term

23
 SpecicaQon II

q yit is either
1. Quarterly change in bank loans scaled by the previous quarter assets to the ith
NBFC or
2. Quarterly change in total credit extended by the ith NBFC scaled by the
previous quarter assets
q zt is yield curve slope, GDP growth and inflation as well as bank-
group variables

q xit is NBFC size, capitalizaQon, liquidity and nonperforming assets
q The region specic Financing Company NBFC and NBFC-quarter
random eects:
where% ! ,% ! ,! %and% ! , ! = 1,2,3,4, %are% identically% and%
!" !" !"#
independently%distributed%normal%variables.%%
24
 Result 1-A: Bank Loans to NBFCs posiQvely related to Bank Priority
Sector Lending, except for SBI Group

PANEL&A:&Bank&Loans&to&NBFCs&
Dependent&Variable& BL/A&&&&
&& (1)& (2)& (3)& &(4)& &&
IC& 0.017& (0.021)& 0.018& (0.021)& 0.017& (0.021)& 0.018& (0.021)&
FCR1& 0.095**& (0.040)& 0.104***& (0.040)& 0.096**& (0.040)& 0.096**& (0.040)&
FCR2& 0.062**& (0.030)& 0.071**& (0.030)& 0.063**& (0.030)& 0.063**& (0.030)&
FCR3& 0.066***& (0.025)& 0.075***& (0.024)& 0.066***& (0.025)& 0.066***& (0.025)&
FCR4& 0.042*& (0.023)& 0.051**& (0.022)& 0.042*& (0.023)& 0.043*& (0.023)&
!
& & & & & & & & &
ICCRISIS& L0.002& (0.005)& L0.003& (0.005)& L0.003& (0.005)& L0.003& (0.005)&
FCCRISIS& L0.027***& (0.008)& L0.029***& (0.008)& L0.026***& (0.008)& L0.027***& (0.008)&
&
ICPSLALL/PSLALL& L0.025& (0.033)&
FCPSLALL/PSLALL& 0.209***& (0.064)& & & & & & &
ICPSLSBI/PSLSBI& &0.000& &(0.028)& & & &0.012& &(0.030)&
FCPSLSBI/PSLSBI& & & 0.078& (0.054)& & & 0.012& (0.058)&
ICPSLOTH/PSLOTH& & & &L0.027& &(0.029)& L0.032& (0.032)&
FCPSLOTH/PSLOTH& & & & & 0.187***& (0.056)& 0.182***& (0.061)&
& & & &
&
LogLLikelihood& &
2681.39& & &
2676.80& & &
2681.72& & &
2681.82& &
! & & & &

25
 Result 1-B: NBFC credit extension is negaQvely related to Bank
Priority Sector Lending, except for SBI Group

PANEL&B:&NBFC&Credit&Extension&
Dependent&Variable& TC/A&&&&&
&& (1)& (2)& (3)& (4)&
IC& 0.054& (0.046)& 0.029& (0.046)& 0.062& (0.046)& 0.064& (0.046)&
FCR1& 0.171***& (0.058)& 0.142**& (0.058)& 0.179***& (0.059)& 0.181***& (0.059)&
FCR2& 0.240***& (0.089)& 0.210**& (0.089)& 0.247***& (0.089)& 0.249***& (0.089)&
FCR3& 0.161***& (0.048)& 0.132***& (0.048)& 0.168***& (0.048)& 0.170***& (0.048)&
FCR4& 0.123**& (0.048)& 0.094**& (0.047)& 0.130***& (0.048)& 0.133***& (0.048)&
& ! & & & & & & & &
ICCRISIS& M0.020*& (0.012)& M0.015& (0.011)& M0.023**& (0.012)& M0.025**& (0.012)&
FCCRISIS& M0.072***& (0.014)& M0.066***& (0.014)& M0.075***& (0.014)& M0.077***& (0.014)&
& & & & & & & & &
ICPSLALL/PSLALL& M0.155*& (0.082)&
FCPSLALL/PSLALL& M0.284***& (0.100)& & & & & & &
ICPSLSBI/PSLSBI& &M0.003& &(0.069)& & & &0.074& &(0.075)&
FCPSLSBI/PSLSBI& & & M0.068& (0.085)& & & 0.041& (0.091)&
ICPSLOTH/PSLOTH& & & &M0.169**& &(0.073)& M0.201**& (0.079)&
FCPSLOTH/PSLOTH& & & & & M0.277***& (0.088)& M0.294***& (0.095)&
& & & & & & & & &
LogMLikelihood& 1056.37& 1051.00& 1058.10& 1058.69&
! & & & &

26
 Result 2-A: Bank loans to NBFCs are negaQvely related to
increases in bank branching in rural areas relaQve to urban
areas, except for the SBI
PANEL&A:&Bank&Loans&to&NBFCs&
Dependent&Variable& BL/A&&&&
&& (1)& (2)& (3)& (4)&
IC& 0.021& (0.021)& 0.047& (0.023)& 0.022& (0.021)& 0.016& (0.023)&
FCR1& 0.095**& (0.040)& 0.097**& (0.041)& 0.096**& (0.040)& 0.090**& (0.041)&
FCR2& 0.063**& (0.031)& 0.067**& (0.031)& 0.064**& (0.030)& 0.058*& (0.032)&
FCR3& 0.066**& (0.026)& 0.068**& (0.026)& 0.066**& (0.025)& 0.060**& (0.027)&
FCR4& 0.041*& (0.024)& 0.044*& (0.025)& 0.042*& (0.023)& 0.036& (0.025)&
& & & & & & & & &
ICCRISIS& L0.005& (0.006)& L0.002& (0.007)& L0.005& (0.006)& L0.003& (0.007)&
FCCRISIS& L0.020**& (0.010)& L0.022**& (0.010)& L0.021**& (0.009)& L0.018*& (0.010)&
& & & & & & & & &
ICRURALL& 0.134& (0.185)&
FCRURALL& L0.604*& (0.355)& & & & & & &
ICRURSBI& &0.004& &(0.130)& & & &L0.071& &(0.153)&
FCRURSBI& & & L0.297& (0.233)& & & L0.144& (0.271)&
ICRUROTH& & & &0.160& &(0.179)& 0.211& (0.211)&
FCRUROTH& & & & & L0.585*& (0.346)& L0.479& (0.402)&
& & & &
&
LogLLikelihood& &
2677.47& & &
2676.57& & &
2677.59& & &
2677.81& &
! & & & &

27
 Result 2-B: NBFC credit extension is posiQvely related to
increases in bank branching in rural areas relaQve to urban
areas, except for the SBI

PANEL&B:&NBFC&Credit&Extension&
Dependent&Variable& TC/A&&&&&&
&& (1)& (2)& (3)& (4)&
IC& 0.046& (0.047)& 0.004& (0.050)& 0.047& (0.047)& H0.008& (0.051)&
FCR1& 0.151**& (0.059)& 0.109*& (0.062)& 0.154***& (0.059)& 0.097& (0.062)&
FCR2& 0.219**& (0.090)& 0.177**& (0.091)& 0.222**& (0.090)& 0.166*& (0.092)&
FCR3& 0.141***& (0.049)& 0.098*& (0.052)& 0.144***& (0.049)& 0.087*& (0.053)&
FCR4& 0.104**& (0.049)& 0.060& (0.052)& 0.107**& (0.049)& 0.049& (0.053)&
& & & & & & & & &
ICCRISIS& H0.026*& (0.014)& H0.005& (0.015)& H0.028**& (0.013)& H0.007& (0.015)&
FCCRISIS& H0.074***& (0.016)& H0.052***& (0.017)& H0.076***& (0.016)& H0.054***& (0.018)&
& & & & & & & & &
ICRURALL& 0.563& (0.457)&
FCRURALL& 0.370& (0.562)& & & & & & &
ICRURSBI& &H0.231& &(0.315)& & & &H0.749**& &(0.370)&
FCRURSBI& & & H0.502& (0.376)& & & H1.026**& (0.437)&
ICRUROTH& & & &0.769*& &(0.443)& 1.303**& (0.519)&
FCRUROTH& & & & & 0.647& (0.545)& 1.381**& (0.633)&
& & & &
&LogHLikelihood& &1051.63& & &1051.72& & &1052.84& & &1057.02& &
! & & & &

28
 Bank-NBFC Transmission in the Crisis of Fall 2008
q A shadow bank run on the NBFCs, resulQng from a run on
1. The private sector banks (transmited to the NBFCs through bank loans)
2. The mutual funds (transmited to the NBFCs through commercial paper).

q RBI Deputy Governor Usha Thorat described the situaQon as follows:

Especially the public sector bank deposits went up and the private sector bank deposits took a
knock. So, the private sector banks were quite resource constrained. Also, the RBI facili<es were
mostly collateralized ones against government securi<es and private sector banks did not have
sucient securi<es above the statutory requirements to be able to take RBI liquidity which
meant they were constrained on liquidity at the same <me that lending by banks to NBFCs
decelerated.

In Aug 2008, some NBFCs faced a liquidity problem. Many of them were even doubSul whether
their CPs would be rolled over. Some of them had to have liquidity infusion from their sponsors.
Bank credit lines started choking. The mutual funds, which had invested in the NBFCs short term
paper, withdrew or started selling these. In fact, the vulnerability of this sector to liquidity risk got
exposed. There was huge pressure on the RBI to open a liquidity window special for NBFCs. When
banks were unwilling to nance NBFCs, the RBI opened a special facility through a structured
vehicle, which was already located in the IDBI.

29
Term Deposit Flight from Private to Public Banks

30
Bank Credit skewed towards SBI Group

31
Priority Sector Lending also skewed to SBI Group

32


Result 3: Bank Loans to NBFCs negaQvely related to the Term to Total
Deposits for the SBI Group


PANEL&A:&Bank&Loans&to&NBFCs&
Dependent&Variable& BL/A&&&&&
&& (1)& (2)& (3)& (4)&
IC& 0.028& (0.022)& 0.016& (0.021)& 0.028& (0.022)& 0.029& (0.022)&
FCR1& 0.128***& (0.041)& 0.116***& (0.039)& 0.115***& (0.041)& 0.125***& (0.041)&
FCR2& 0.096***& (0.031)& 0.084***& (0.030)& 0.082***& (0.031)& 0.092***& (0.032)&
FCR3& 0.099***& (0.026)& 0.087***& (0.024)& 0.086***& (0.026)& 0.095***& (0.026)&
FCR4& 0.075***& (0.024)& 0.063***& (0.022)& 0.062**& (0.024)& 0.071***& (0.024)&
& & & & & & & & &
ICCRISIS& L0.002& (0.005)& L0.002& (0.005)& L0.004& (0.005)& L0.002& (0.005)&
FCCRISIS& L0.031***& (0.008)& L0.032***& (0.008)& L0.029***& (0.008)& L0.031***& (0.009)&
& & & & & & & & &
ICTDALL/TDALL& L0.125& (0.110)&
FCTDALL/PSLALL& L0.296*& (0.155)& & & & & & &
ICTDSBI/TDSBI& &0.046& &(0.041)& & & &0.013& &(0.046)&
FCTDSBI/TDSBI& & & L0.173***& (0.067)& & & L0.209***& (0.071)&
ICTDOTH/TDOTH& & & &L0.103& &(0.077)& L0.142& (0.087)&
FCTDOTH/TDOTH& & & & & L0.061& (0.128)& L0.060& (0.134)&
& & & &
&LogLLikelihood& &2677.63& & &2680.53& & &2676.67& & &2681.87& &
! & & & &

33
 Summary of Results
q Bank lending to the non-deposit taking NBFCs

qforms a signicant proporQon of these NBFCs liabiliQes

quctuates in line with bank allocaQon to priority lending sectors
qappears to decrease as the banks expand in rural areas relaQve to
urban areas

q However, bank lending to these NBFCs is virtually non-existent for the
largest state-owned bank, State Bank of India (SBI) and its aliates
which have strong rural branching.

q These bank-NBFC linkages are present for those NBFCs that do loans or
asset nancing and not for investment companies, and also aect the
credit growth of these NBFCs.

q StarQng with the nancial crisis of Fall 2008, bank lending to these NBFCs
experienced a permanent contracQon that is related to the shi` of term
deposits towards SBI Group.


34



 Conclusions
q The non-deposit taking NBFCs in India likely represent a
completeness of credit allocaQon in non-metropolitan areas of the
Indian economy by banks with less than fully-developed branching
networks.

q This NBFC role has been potenQally constrained by distorQons in

bank deposit base arising from a lack of level-playing eld in the
perceived government support of dierent banking groups.

q Since these NBFCs are relaQvely well-regulated on the capital front,

it is primarily their linkage to the banking sector that stands out as
a potenQal concern for systemic risk consideraQons.

q Furthermore, our results highlight that shadow banking in emerging

markets may look quite dierent from that in developed
economies.

35