Shadow Banking in India: Do bank sponsored asset management companies (AMCs) perform liquidity transformation through exposure to non-banking finance companies (NBFC) in their debt oriented schemes and will this increase the systemic risk of a bank due to a possible joint exposure to NBFCs?

Abstract

This research studies the joint exposure that Indian banks face through their balance sheet i.e. direct lending, investment and their off-balance sheet i.e. stand by letter of credit (SBLC) issued on behalf of Indian Non-banking finance companies (NBFC) for their commercial paper and an indirect exposure to the same NBFC through its asset management arms. Using data from Reserve Bank of India, Micro Finance Institutions Network, monthly portfolio disclosure of asset management companies’ and annual reports of NBFCs and banks during the period 2012 to 2018, Ministry of Corporate Affairs (MCA) index charges, company shelf prospectus the paper tries to address three questions: first, whether a joint exposure exists to a particular NBFC at a bank level and at the banks’ mutual fund arm level; second, whether asset management arms of these banks function as shadow banks and undertake liquidity transformation through investing in NBFC floated debentures and commercial paper and how this adds to the joint exposure of the Indian banks; and third whether the banks financial interdependency with these financial institutions such as NBFCs and mutual funds affects the overall systemic risk. The paper uses the Bai – Perron (1998) model with multiple structural breaks for assessing the liquidity transformation in debt schemes and the Diebold – Yilmaz (2009, 2012 and 2014) models to estimate the return spill-over effect (financial interdependency)4