Parallel Financial System

Parallel Financial System
Parallel Financial System, refers to the supplementary monetary flow in an

economy along with the primary currency, without the former taking control over
the currency in circulation. This system is a key, and helps in not only giving the
economy the much needed push in its aggregate demand but also sustaining it,
thereby acting as a macroeconomic stabilizer.
Dating Parallel Financial Systems
Parallel markets were the direct offspring of the Second World War. The
economic situation then led to the formulation of new credit markets, that
operated independently, with limited interaction with traditional markets. The
oldest instance of a parallel financial system would be the implementation of
Swiss WIR implemented in 1934 to discourage liquidity in the market during
Great Depression.
In todays world its Euro currency market that acts a money spinner to the
economies of many developed countries
Euro-currency market plays a major role in the economies of developed countries;
provides additional liquidity. Thus, as a parallel market it leads to a significant
increase of credit resources, counteracting the national policies and often
accounting for inflation.
Parallel Financial System in India
In the Indian context, the system is mainly spearheaded by the NBFCs along with
quasi-formal and informal systems like Nidhi, Chit Funds, Gold Saving and Loan
Companies, Pawn Brokers, etc. Theyre regulated by the government through
1. Applicability of the Usurious Loans Act, 1918
2. The Interest Act, 1978.
However, Given the diverse liquidity requirements of a vibrant start-up

environment and working capital needs of rural businesses, a regulated parallel
financial segment rather than public sector banks grappling with bad loans is the
need of the hour.
Shadow Banking As an instrument of a parallel financial system.
Shadow banking refers to all the non-bank financial intermediaries that provide
services similar to those of traditional commercial banks. They generally carry out
traditional banking functions, but do so outside the traditional system of
regulated depository institutions, and thereby run parallel to the existing financial
system. Shadow banking has grown in importance in the last decade and was one
of the primary factors in the sub-prime mortgage crisis of 2007-2008 and the
global recession that followed it.
2
Dangers of a Parallel Financial System
Makes markets more susceptible to concentration and anticompetitive

practices.
Shift in lending from banks to the parallel system distorts the distribution
of credit.
Financial fragility increases as banks declining market share weakens
their portfolios and exposes the deposit insurance fund to additional risk.
Affects the primary role of banks in transmitting monetary policy and
deploying central bank liquidity to smooth volatility, prevent disruptions,
and manage crises.
How does FSB plan to tackle the dangers of shadow banks?
The Financial Stability Boards (FSB) exercise, measures the source and
deployment of funds, but does not gauge the risks that shadow banking poses to
the financial system. The FSB also does not measure the amount of debt used to
purchase assets (leverage), the degree to which the system can amplify
problems, or the channels through which problems move from one sector to
another.
The FSB plans to use what it learns about shadow banks from macro mapping,
ie, information gathered from regulatory and supervisory reports and information
gleaned from the markets about new trends, instruments, and linkages info and
correlate that information to the four shadow banking activities (maturity and
liquidity transformation, credit risk transfer, and leverage) to devise a systemic
risk map to determine which activities, if any, may pose a systemic risk.
Conclusion
Though the disadvantages and risks of shadow banks have been highlighted here,
it is undeniable that shadow banks, including NBFCs and other service a need of
the population that is left unaddressed by the mainstream banks. Such entities of
a parallel financial system sub serve the economy by playing a complimentary and
supplementary role to mainstream banks and also aid in furthering financial
inclusion, which is an important issue for India.
Large banks due to their reluctance to enter into less profitable areas, have left
41% of Indian households without bank accounts, thus making them an easy target
for chit funds. Hence, instead of aiming to completely abolish shadow banking,
the Government must increase regulatory oversight and keep the law/rules
updated to dealing with the changing economic environment. While enabling
prudential growth of the sector, financial stability must be maintained and
consumers and depositors interests must be protected.

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Parallel Financial System

Parallel Financial System, refers to the supplementary monetary flow in an

Dating Parallel Financial Systems

Parallel Financial System in India

However, Given the diverse liquidity requirements of a vibrant start-up

Shadow Banking As an instrument of a parallel financial system.

Dangers of a Parallel Financial System

Makes markets more susceptible to concentration and anticompetitive

How does FSB plan to tackle the dangers of shadow banks?

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