By | January 18, 2021

The shadow economy exists in almost all countries of the world. Its patterns and structure have a regional dimension. Analysis of the shadow economy shows key features, which are common to all countries in a particular economic region.

The average index of the shadow economy is 18% for OECD countries, and for the transition economies, this index is about 37%, which confirms the theory of regionalization of the economy.

Shadow economy depends not only on economic but also on socio political factors. The combination of these factors creates the motivation of the participants of the shadow economy.

The burden of direct and indirect taxes high density of regulations and level of corruption are considered to be the main factors, which lead to high indicators of the shadow economy in transition economies. Based on these results, the most outstanding problems that have the greatest impact on entrepreneurs were distinguished for each country.

NBFC, Mutual Fund (Shadow Banking) and the Crisis

A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities such as stocks, bonds, money market instruments, and other assets.

A shadow banking system is a group of financial intermediaries facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight.

  • Mutual fund companies have invested in NBFC. Banks have lent to NBFC on the basis of commercial papers (an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts payable and inventories and meeting short-term liabilities).
    • Now such pieces of paper are nothing but junk. Since August 27, 2018, when IL&FS non-banking financial company was unable to repay the loan at the scheduled time and missed deadlines, the share market is retracting, NBFC stock prices started tumbling down.
  • About 25%, of loans in India, is taken from 50-odd shadow banks(NBFC) that have expanded quickly. They are less heavily regulated and lend in particular areas such as housing.
    • They are usually prohibited from taking deposits so fund themselves with debt. They are big enough to damage India’s entire financial system. Mutual funds, which are sold to the public, have $55bn of exposure to them, or 11% of total assets under management.
    • Conventional banks have loaned $70bn to shadow banks, the equivalent of two-fifths of the former’s core capital
  • Even if a full crisis does not erupt shadow banks may be forced to shrink. When combined with the rising NPAs of state banks, that would mean that 75% of India’s financial system is on crutches.

The Risks of Shadow Banking

  • Borrowing short and lending long is a high-risk game as the IL&FS collapse amply manifests. (Generally, NBFC invests in companies with long gestation period, like infrastructural projects where returns come in 12-14 years, while they take capital through short term funds such as mutual funds which entail early repayments within 3-4 years, thereby getting caught in a trap of high risks.) In the aftermath, the government has taken it over though it already indirectly owned 40% of it.
    • There is a huge mistrust in the financial market with mutual funds and banks are reluctant to lend to NBFCs. In spite of reports of solid capital ratios, there is a great deal of apprehension about the possible time-bombs buried in their balance sheets. For months now, NBFCs have been facing a liquidity crunch.
  • Defaults by such NBFCs are fatal enough to damage India’s entire financial system with mutual funds – which are sold to the public – having $ 55 billion of exposure to them, or 11% of total assets under management.
    • Traditional banks have loaned $ 70 billion to NBFCs which approximately equals 40% of the banks’ core capital.

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