The US Fed Reserve seems to have realised that there are factors other than interest that need to be addressed to rein in inflation. Many of them of course are not within its remit but the looming presence of shadow banks in the US has not escaped its attention as indeed of the entire tribe of lawmakers in the US. Even though the truth is that they are widely prevalent in most countries including India and China as they are indeed a necessary evil given the fact that they step in to fill the vacuum left by the mainstream banking sector.
The quarter percent hike in interest rate announced by the Federal Reserve on 22nd March applies slight break on relentless and large doses of monthly increase in interest rates with a view to taming the monster of inflation, raging at 6 percent. While, the the Fed Reserve also seems to have realised that there are factors other than interest that need to be addressed to rein in inflation.
Inflation blues
The let up in the size of the hike in the last two consecutive months from the earlier 50 basis points to 25 basis points both in February and March this year is the result of a chastening realisation that no economic decision is free of side effects.
The recent collapse of Silicon Valley Bank (SVB) and Signature Bank has made the authorities go slow as their experiences as indeed the experiences of many others brought home the grim reality that as you hike interest rates, correspondingly and conversely bonds are denuded of their values given the time-tested inverse relationship between the two that in fact triggered to a substantial degree the collapse of SVB.
Also Read: US Fed Rate Hike Highlights: Jerome Powell hikes policy rate by 25 bps despite bank turmoil
So, the Fed Reserve was torn between a purpose and doubt---which one is more important, containing inflation or stopping bloodbath in the bond markets. In the event, it chose a via media and applied brakes on the size of the rate hikes especially in the light of inflation showing signs of abating and the tightness in the job market. Credit squeeze takes a toll on job creation. This is indeed another side-effect of obsessive focus on monetary policy in taming inflation.
Shadow banks under watch
Unstated though, the Fed Reserve also seems to have realised that there are factors other than interest that need to be addressed to rein in inflation. Many of them of course are not within its remit but the looming presence of shadow banks in the US has not escaped its attention as indeed of the entire tribe of lawmakers in the US. Shadow banks aka NBFC or non-banking financial corporations are a rage both in the US and India. By definition, they are either unregulated or not regulated at par with the banking sector.
Examples of shadow banks or financial intermediaries not subject to regulation include hedge funds, private equity funds, mortgage lenders, and even large investment banks.
The shadow banking system can also refer to unregulated activities by regulated institutions, which include financial instruments like credit default swaps. A realisation has dawned that to curb money supply, these so-called rogue institutions must also be reined in.
It is not as if shadow banks are unique to the US nor are they a recent phenomenon. The truth is they are widely prevalent in most of the countries including India and China. They are indeed a necessary evil given the fact that they step in to fill the vacuum left by the mainstream banking sector especially in hinterlands. In India, cooperative banks along with NBFC have been the pain the neck of the central bank, RBI what with they coming largely within the remit of state governments insofar as regulations go though RBI has been partially successful in clawing its way into their fief.
But they put their depositors to a great risk---unlike the depositors in the mainstream banks who enjoy deposit insurance both in India and the US, depositors in shadow banks are left high and dry when things spin out of control.
India better off
To the credit of the RBI, it must be said it has not allowed grass to grow under its feet or looked the other way even as their looming presence is there for everyone to see.
Shadow banks account for a quarter of the total loans in India. India had 10,000 shadow banks as of March 2021, the latest RBI data available, with assets of 54 trillion rupees ($680 billion) or about one-fourth that of the banking sector. Several of the biggest shadow banks are listed on the stock exchanges. RBI has done well to ask them to recognise bad debts on a daily basis from the leisurely monthly exercise of the past much to the consternation and resentment of NBFCs.
US senators are pushing for a concerted action against the freewheeling and untrammelled ways of shadow banks but so far concrete, substantial steps are yet to be spelled out. No wonder, it is now widely acknowledged that the RBI has been one up in its regulatory and monitoring role vis-à-vis the US Fed Reserve, which is seen to be willing to hit but afraid to wound.
— The author, S Murlidharan, is a CA by qualification, and writes on economic issues, fiscal and commercial laws. The views expressed are personal.
Read his previous articles here
(Edited by : C H Unnikrishnan)
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