Rebooting Economy XVIII: Does quality education really matter to India?

Without quality education, no economy can progress, at least not in today's technology and knowledge-driven globalised world order. Economists and policymakers know this well yet pay no attention

Prasanna Mohanty | August 18, 2020 | Updated 10:05 IST

Appointing teachers of higher learning on contract, temporary or ad hoc basis without job security or social security is the norm, not an aberration in India

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One of the major causes of India's continued backwardness has been its dismal quality of human capital. The state of affairs is so scary that the government often doesn't find the courage or let the full facts be known, barring occasional bouts of catharsis.

The only official document that provides a complete picture of the quality of human capital in India's workforce was published in November 2012, titled, "eSkill Development". It was the work of the man who brought the telecom revolution to India, Sam Pitroda. He headed the National Knowledge Commission and was adviser to the then Prime Minister Manmohan Singh.

Its content sent shock waves then.

Three key revelations were: (i) "38% of Indian workforce is illiterate, 25% has education up to primary school level and the remaining 36% has an education level of middle and higher-level" (ii) "80% of Indian workforce does not possess any marketable skills" (iii) "among persons within the age group (15-29 years) only about 2% have received formal vocational training and 8% non-formal vocational training... The comparative data for developed economies is Korea (96%), Germany (75%), Japan (80%), and the United Kingdom (68%)".

Also Read: Rebooting Economy XVII: Why governments promote shadow banking

No official document since then has attempted to update this information. The last attempt was made in 2016, which was a half-hearted one and mentioned only the skilling part. That was the labour ministry's Report on Education, Skill Development and Labour Force (Volume III), 2015-16, released in September 2016.

About skilling level, it said: "Out of 5.4 per cent vocationally trained persons, 2.0 per cent received formal training and the remaining 3.4 per cent are informally trained... percentages of formally trained persons are estimated at 1.8 per cent and 2.6 per cent in rural and urban sectors, respectively".  

It said nothing about the education level of the workforce, though a lot was said on the state of education in general. The employment-unemployment surveys (EUSs) that formed the basis for this report (5th EUS), have been discontinued. The sixth survey (EUS) was conducted but its report was not released.

The only official who has expressed his disapproval about poor quality education in recent times is VK Saraswat, a member of the government think tank Niti Aayog. While releasing a private report on education in April 2019, he said: "If we neglect higher education, we neglect growth of the nation as a whole because higher education contributes to the nation's growth. If we have to transform our demography, we have to take a look... the situation is grim and not a happy situation. People say a large number of graduates and PhDs are coming out, but we know the quality of those products/graduates/PhDs."

What really is happening to Indian education? Here is a closer look.

Do education ministers count in India?

On August 11, 2020, newspapers across the country carried an unusual piece of news. 

Some of the headlines were: "25 years after clearing Class XI at 29, Jharkhand education minister goes back to school", "India: 53-year-old Jharkhand education minister goes back to Class 11", "Hurt by 'under-qualified' jibe, Jharkhand's 10th pass Education Minister goes back to school" and "Teachers of govt-aided school where Jharkhand HRD minister applied for admission 'unpaid' for 4-month".

One way of looking at it is as a positive development, which is how the newspapers approached it, notwithstanding the mismatch in his qualification: Class X pass or Class XI? 

The other way is to treat it as a disturbing development: What justification is there for an Indian state's choice of "under-qualified" person to run the education ministry more than 70 years after independence? According to Jharkhand's official website, there are 395 universities and colleges in the state. How well would those educational institutions be provided quality leadership?

Here's more about the case, gleaned from those reports: the minister, Jagarnath Mahato, had set up the very educational institution in which he was seeking admission way back in 2006; he is chairman of its governing body; it is a government-aided intermediate college named Devi Mahato Memorial Intermediate College (DMMIC) and its teachers have not been paid for four months.

Also Read: Rebooting Economy XVI: How governments run shadow banking and risk financial stability

Here is more: Mahato is the minister for school education and literacy. He told Business Today that Chief Minister Hemant Soren holds charge of higher education but has delegated the authority to him to field questions in the Assembly. Soren is Class XII pass, according to his election affidavit. Conversations with local journalists revealed Mahato is the de facto higher education minister. 

Cut back to September 2011. 

Puducherry's education minister PML Kalyanasundaram gets caught using a proxy for his Class X examination conducted by the Tamil Nadu government. As police chased him, he disappeared, sacked as minister in absentia, later arrested and jailed for two years. Last heard, he was acquitted of the exam fraud in 2013 by a Tamil Nadu court and was waiting to get back to his ministerial job kept vacant all this while.

At the national level, the situation is disturbing too.

The incumbent central education minister Ramesh Pokhriyal 'Nishank', who piloted the National Education Policy 2020 (NEP 2020), courted controversy for claiming multiple doctorate degrees, two of which are from an unrecognised open university of Sri Lanka, as an RTI reply revealed and newspapers duly reported. A court case has been filed against him, the fate of which is not yet known. His profile on the ministry's website does not mention his educational qualifications.

One of his predecessors was Smriti Irani, who initiated the NEP 2020 by appointing a committee led by former cabinet secretary TSR Subramanian who is no longer with us. She too landed in controversy for providing conflicting information about her educational qualifications. A court case was filed, the fate of which is not clear. Her electoral affidavits were found missing from the official website of the Election Commission of India (ECI).

These four cases are not about individuals or politicians or their educational credentials. It is all only about the education ministers in the state and at the Centre. The choices reflect the priority accorded to a critical function in a developing economy. 

There is no point in the old and cliched argument that educational qualifications or degrees don't necessarily reflect education or equate with competence or knowledge. This argument negates the very concept of institutional education.

Moreover, there is little space for such an argument after more than 70 years of the mid-night tryst with destiny in 1947. That thousands of highly qualified people are unemployed, queuing up for manual jobs or engaged in selling vegetables, pani puri and other menial work all over India is not a revelation. 

The huge popularity of the rural job guarantee scheme MGNREGS, providing livelihoods (manual jobs) to millions of individuals, is evidence enough. Currently, 203.5 million individuals are MGNREGS work cardholders and 64.7 million individuals worked under the scheme in FY21 (since April 1), according to the official website.

The lockdown is not the only compulsion. In the previous fiscals, their numbers (who worked under MGNREGS) stood at 64.3 million in FY20, 77.7 million in FY19, 75.9 million in FY18 and 76.7 million in FY17, according to the same website.

Here is just one headline before the lockdown hit, among several others such news, to dispel the notion of selective use of information at the time of pandemic-induced economic disruptions. 

In September 2018, a headline read: "Job scarcity! 81,700 graduates including 3,700 PhD-holders apply for 62 peon posts in UP Police".

The text revealed there were 28,000 post-graduate candidates among them.

Do teachers count in India?

On July 30, 2020, another piece of shocking news hit the headlines.

It said the Tripura government had sought the Supreme Court's permission to "re-appoint" more than 10,000 teachers - post-graduate, graduate and under-graduate teachers - as peons, night guards, gardeners, cooks, and lower division clerks.

Also Read: Rebooting Economy XV: Why shadow banking should worry policymakers in India and elsewhere

The apex court had earlier upheld a high court order setting aside the state's 2003 employment policy on procedural grounds and quashing the appointment of thousands of teachers. The state was asked to frame a new policy, which it did in 2017 but continued with ad hoc appointments claiming that there was a shortage of teachers and the recruitment process mandated in the new policy, public advertisement seeking candidates and written examinations to select etc., could not be completed in time.

When a contempt proceeding was initiated this year for continued ad hoc appointments, the state ran to the apex court seeking re-appoint of those teachers to grade C and D posts lying vacant (in a time of job scarcity, this too is shocking in equal measure). It can be safely assumed that the state had consulted and secured their prior consent before proposing their re-appointment as peons, gardeners, cooks, night guards, etc. 

Malfeasance in the appointment of teachers is not unknown. 

Former Haryana Chief Minister Om Prakash Chautala landed in jail in 2013, along with his son Ajay Chautala, for alleged corruption in the appointment of teachers. While the father is in jail, the son got out in 2019 after the grandson, Dushyant Chautala, became deputy chief minister of Haryana.

Here are a few more shocking revelations.

Nearly 43% of Delhi University faculty are "ad hoc" teachers, working on a 4-month contract for years. The contract gets renewed after every four-month period with one-day break in service to mark discontinuity and pre-empt any claim for a permanent teaching job. The ad hoc teachers get no increment, no promotion, no social security benefits like PF, sick leave, maternity leave, medical benefits, etc. They are stuck at the same entry-level pay of an Assistant Professor even after 10, 15, and 20 years of teaching.

Delhi University Teachers' Association (DUTA) president Rajib Ray says there are 4,500 such ad hoc teachers in Delhi University, out of a total faculty of 10,500. A majority of ad hoc teachers belong to marginalised societies. Of 4,500 ad hoc teachers, 2,400 (53%) belong to OBC, SC, ST, and physically challenged categories. Most ad hoc teachers have been there for 10-12 years and are permanently stuck at entry-level pay.

Ray says these ad hoc teachers tick all the qualifying norms set by the University Grant Commission (UGC). The only silver lining is they get paid as per the UGC scale, although at the very same entry-level year after year.

Then there are "guest teachers" in DU. 

Ray says 4,000 guest teachers are teaching in the Delhi University's School of Open Learning (SOL) and Non-Collegiate Women's Education Board (NCWEB). This is a different category and is not counted among the 10,500 teachers. 

They are paid Rs 1,500 per lecture with a monthly pay cap of Rs 50,000. That is, they can't take more than a certain number of classes. Their engagement is for one semester at a time. This, Ray assures, is a massive improvement. A year and a half ago, they were paid Rs 1,000 per lecture with a monthly pay cap of Rs 25,000. They too tick all UGC prescribed norms. 

Delhi University is no ordinary institution. It is a central university, one of the very top in India to which students flock from all around India. It was set up in 1922 through a central law. In the 2020 ranking of universities by the Union Ministry of Human Resource Development (MHRD), released recently, DU was placed at number 11. 

An interesting side about the MHRD ranking: though the parameters for ranking include the state of faculty, the DU score sheet does not even mention it.

Appointing teachers of higher learning on contract, temporary or ad hoc basis without job security or social security is the norm, not an aberration in India. 

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Here is another example from July 2020. 

Another premier central university, Savitribai Phule Pune University, advertised for 5 posts of teachers for three posts in English and two in commerce department on July 27, 2020. 

All posts are marked "contractual", for a period of 8 to 9 months (contract would be valid up to May 31, 2021, and the last date for filing applications is August 18, 2020), with a "consolidated" pay of Rs 30,000 per month. There is no mention of whether it is renewable, what career prospects it offers, or is there a chance of being made permanent. Nor any mention of social security. 

Qualifications: the candidates must tick all the UGC norms for appointment as Assistant Professors: NET/SET/Ph.D. etc. 

The advertisement for the commerce Department is reproduced for reference.

This university was ranked 9th in the MHRD's 2020 list of universities, two places ahead of DU. 

State of teachers of higher learning in India

There is no reliable or complete information on the service condition of teachers in Indian colleges and universities. 

The DUTA president Ray says in 20-odd central universities, which are part of a federation of teachers' associations and which he heads too, there would probably be 20 to 50 teachers out of 200-800 of total faculty who would be having one-year contracts (6-10% of the total). 

The HRD ministry's All India Survey on Higher Education provides some information but excludes private and deemed universities from its ambit, and hence grossly incomplete. It excludes private institutions because they are not required to provide relevant details to its database (www.aishe.gov.in) in the first place. This database provides the basis for the MHRD's ranking.

Also Read: Rebooting Economy XIII: Why Indian corporates are debt-ridden

Private universities have been growing and have a big presence. They numbered 385 in 2018-19, out of 993 universities listed in the MHRD database, accounting for 39% of the total Indian universities.

The MHRD's last survey of 2018-19, released in August 2019, showed an average of 6.8% faculty members in universities and colleges marked as "temporary" during the period of FY13-FY19. 

The document did not define "temporary". It defined "teaching staff" which had a host of positions that can be assumed to be without job and social security: part-time, ad hoc, temporary, contract, and visiting teachers. "Temporary" teachers are a part of this universe.

To conclude, here is a question to ponder over: Does or can such a society or a country aspire to or even deserve quality education?

Also Read: Rebooting Economy XII: Is private sector inherently more efficient than public sector?

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Rebooting Economy XVII: Why governments promote shadow banking

 Solutions to shadow banking risks are well-documented: tightening regulations, extending central banks' cover as lender-of-last-resort, mandating deposit insurance to prevent overnight collapse, controlling trade in highly complex, opaque and high-risk derivatives and changing short-term-funding-long-term-lending business model

Prasanna Mohanty | August 12, 2020 | Updated 22:21 IST

There are several categories of NBFCs in India, some of them run by the government and some by private players

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Shadow banking isn't exactly a neoliberal (radical right) concept, it existed earlier, but as Prof. Nouriel Roubini of  New York University and Prof. Stephen Mihm of the University of Georgia pointed out in their 2010 book "Crisis Economics" it entered mainstream financing in a big way and turned the rules of the game in the neoliberal era.  

They wrote: "A growing number of people who joined the financial services industry from the 1980s onward realised that they could make plenty of money, so long as they were willing to walk the banking tightrope without a safety net underneath. There were ways to conduct banking free of regulations, but also free of the protections afforded ordinary banks. So began a game of "regulatory arbitrage," the purposeful evasion of regulations in pursuit of higher profits. This quest gave rise to the shadow banks."

It is by now well-documented that governments world over continue to run and promote shadow banking entities even after the 2007-08 Great Depression, knowing fully well that they played a central role in it, which is also well-documented.  

The question then is why governments do it. Why this extraordinary inclination for self-inflicted injury?

Also Read: Rebooting Economy XVI: How governments run shadow banking and risk financial stability

The "Crisis Economics", in the quote above, gives a clear answer that goes unchallenged: shadow banking is designed to evade regulation to make higher profit.  

Governments and government-run entities running and promoting shadow banking have their own explanations. Here are some of them.  

Alarming global growth in risky shadow banking (NBFIs)

The global watchdog of shadow banking, Financial Stability Board (FSB), a multinational agency set up in 2011 to monitor shadow banking and recommend policy responses, makes telling points in its latest report, "Global Monitoring Report on Non-Bank Financial Intermediation 2019", released on January 19, 2020.  

The opening sentence of the report reads: "Non-bank financing is a valuable source of financing for many firms and households. It facilitates competition among financing providers and supports economic activity. Notwithstanding this, non-bank financing may become a source of systemic risk - both directly and through its interconnectedness with other parts of the financial system - if it involves activities that are typically performed by banks, such as maturity/liquidity transformation and the creation of leverage."

The report does not explain why this "valuable source of finance" can't be better regulated like banks since it poses "systemic risk" directly and indirectly.

The risk from shadow banking is not small as the 2007-08 experience shows. Further, the report narrows down to the shadow banking segment that poses "systemic risk", classified as "narrow measure" of shadow banking or "Non-Banking Financial Intermediation" (NBFI). India's Non-Banking Financial Companies (NBFCs) fall in this category.  

The report says NBFIs are growing even post-2007-08 crisis.  

The relevant sentence reads: "The narrow measure (NBFIs) has grown faster than GDP since 2012, increasing to 77% of all participating jurisdictions' GDP in 2018 from 64% in 2012. This trend is observed in most jurisdictions..."  It measures 29 jurisdictions, including India, that constitute 80% of global GDP.

The size of these risky NBFIs was $50.9 trillion in 2018 - bigger than the combined GDP of the US, China, India and several other big economies. It was 67% of the global GDP in 2018, taking global GDP at $77.2 trillion as on December 1, 2018, according to the database of Washington-based Institute for International Finance (IIF).  

The assets of NBFIs constitute 13.4% of the total assets of all financial entities.

Also Read: Rebooting Economy XV: Why shadow banking should worry policymakers in India and elsewhere

This segment grew by 1.7% in 2018. The only silver lining is that this growth rate was slower than the annual average growth of 8.5% recorded during 2012-17.

The FSB 2020 report explains the "systemic risk" of NBFIs comes from their activities of "credit intermediation" that "involves maturity/liquidity transformation, leverage or imperfect credit risk transfer and/or regulatory arbitrage" (gap in regulations).

As for India, it is a major driver of NBFIs globally.

In 2018, global NBFIs grew at 1.7% but in India's NBFIs (NBFCs) grew by about 14%. India was one of 5 nations recording more than 10% growth. The others were: Argentina, Hong Kong, Italy, and Russia.

In the following graph, India (IN) is fourth from left, the first three being Argentina (AG), Hong Kong (HK), and Russia (RU). Fifth is Italy (IT).

Here is an interesting bit: "Eight jurisdictions reported a decline in the narrow measure (NBFIs), with the largest decline in dollar terms reported by China."

Size and growth in all shadow banking entities (MUNFIs)

The actual size of all shadow banking entities, classified as "broad measure" of all NBFIs or "Monitoring Universe of Non-bank Financial Intermediation" (MUNFI), is far bigger: $183.6 trillion in 2018 or 48.5% of financial assets of all financial entities ($379 trillion) or 238% of global GDP (using the IIF's database on global GDP).

The silver lining, in this case, is the growth in MUNFIs was (minus) 0.1% in 2018, as against an average annual growth rate of 7.8% during 2012-17.

How does one keep such a big and powerful financial segment from hobbling global economy again without tight regulations?

India's excuse for running and promoting shadow banking

India's NBFCs fit the description and working of NBFIs and are considered as such by the FSB.

The opening line of India's banking regulator RBI's Fiscal Stability Report, released on July 24, 2020, reads: "NBFCs complement banks in extending credit in the economy and they are a vital cog in the wheel for extending last mile credit needs. There were 9,543 NBFCs registered with the RBI as on September 30, 2019 (excluding HFCs), of which 82 were deposit accepting (NBFCs-D) and 274 were systemically important non-deposit taking NBFCs (NBFCs-ND-SI).

"As on March 31, 2019, the total assets of NBFCs and HFCs was Rs 44.4 lakh crore (NBFCs: 70 per cent; HFCs: 30 per cent), which is approximately one-fourth the size of the assets of the scheduled commercial banks (Rs166 lakh crore)."

The two big NBFCs that collapsed in 2018 and 2019, IL&FS was a non-deposit taking (NBFCs-ND-SI) and DHFL a deposit-taking (NBFCs-D) NBFCs.

There are several categories of NBFCs in India, some of them run by the government and some by private players.

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Does the RBI regulate them all and as tightly as conventional banks?

Its own Trend and Progress of Banking in India, released on December 21, 2017, says: "The regulatory and supervisory architecture is, however, focused more on systemically important non-deposit taking NBFCs (with asset size Rs 5 billion and above) and deposit accepting NBFCs with light-touch regulation for other non-deposit taking NBFCs.  

"Certain categories of entities carrying out NBFI activities are exempt from the Reserve Bank's regulation as they are being regulated by other regulators. They include housing finance companies (HFCs), mutual funds, insurance companies, stockbroking companies, merchant banking companies, and venture capital funds (VCFs), which are often referred to as the 'shadow banking system'."

Here is more. The RBI's FAQs on NBFCs have a question (number 9): "Does the Reserve Bank regulate all financial companies?"   

The answer: "No. Housing Finance Companies (HFCs), Merchant Banking Companies, Stock Exchanges, Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies and Chit Fund Companies are NBFCs but they have been exempted from the requirement of registration under Section 45-IA of the RBI Act, 1934 subject to certain conditions." These are regulated by different entities "for avoiding duality of regulation".

From this, it would appear that the RBI "regulates" only the systematically important non-deposit taking NBFCs (NBFCs-ND-SI) whose asset size is Rs 500 crore or more.  

But the overnight collapse of IL&FS, an NBFC-ND-SI, in 2018 is evidence that it didn't exercise its existing powers. The Serious Fraud Investigation Office (SFIO), the statutory corporate fraud investigating agency, investigated and filed a report on the functioning of IL&FS subsidiary, IL&FS Financial Services Ltd (IFIN), with a special court in Mumbai on May 30, 2019.

It squarely blamed the RBI for its gross inaction, allowing IFIN to continue operating after detecting financial frauds in 2015, 2016, and 2017.

A few days later, on June 4, 2019, the RBI explained that it had given IFIN time until 2019 to clean up its books. On July 22, 2020, the National Financial Reporting Authority (NFRA), a new regulatory authority set up in 2018, debarred IFIN's auditor former Deloitte India CEO Udayan Sen, for seven years and imposed a penalty of Rs 25 lakh for financial frauds, concluding that he "had been totally compromised".

Like the FSB, the RBI does not explain why NBFCs are not or can't be subjected to tough banking regulations while claiming nevertheless that "NBFCs complement banks in extending credit in the economy and they are a vital cog in the wheel for extending last-mile credit needs".

Why shadow banking keeps growing even after 2007-08 meltdowns?

Notwithstanding flimsy explanations justifying shadow banking, here is a critical fact that has escaped serious scrutiny and needs to be red-flagged.

The World Bank's 2013 report, "Rethinking the Role of the State in Finance", noted with apprehension how banking ownership has sharply shifted from government hands (public sector) to private hands.

The graph below shows a sharp fall in government ownership of banks in developing economies.

The report commented that post-2007-08 meltdowns the developed economies witnessed an "uptick" in the share of state-owned banks post-crisis "through bailouts, mergers, recapitalisation and nationalisation of distressed financial institutions" but "declined sharply" in developing economies.

Is this change in bank ownership in developing economies good?

The report sounded caution and pointed out that the 2007-08 crisis brought to the fore the potential role of state-owned banks in "stabilising aggregate credit".

Also Read: Rebooting Economy XIII: Why Indian corporates are debt-ridden

It also observed that state-owned banks "still dominate the process of financial intermediation" in some countries and went on to list them: "For instance, state-owned banks still dominate the process of financial intermediation in Algeria, Belarus, China, the Arab Republic of Egypt, India, and the Syrian Arab Republic, where the asset market share of these banks exceeded half the assets of the banking system in 2010."

Recall how the FSB's 2020 report flagged off NBFIs' "credit intermediation" activities as the one posing "systemic risk" to financial systems. It is worth noting that India and China were two big economies that had escaped the full wrath of the 2007-08 financial meltdowns.  

Does that say something about the ownership pattern of banks?

The World Bank report also explained what went wrong with financial systems: "Many institutions and instruments were allowed to grow highly complex and non-transparent. Information on interconnections and exposures of financial institutions was lacking. The increasing use of over-the-counter financial derivatives enabled financial institutions to transfer or to take on risk in non-transparent ways, rapidly and without the necessary capital for ultimate risk-taking institutions to be able to withstand losses when they became apparent."

How bank ownership is critical to US

Here is another graph about shadow banking and their connection with the 2007-08 financial meltdowns in the US.

This graph is from a working paper "Mortgage Debt and Shadow Banks" published by the Netherlands' central bank De Nederlandsche Bank on March 1, 2018. The study was carried out in collaboration with the University of Groningen (the Netherlands).

Mark how the share of shadow banks (red line) in the US peaked just before 2009 and that of the state-owned banks (blue line) was its lowest then.

What to do about shadow banks?

The solutions are well-known and documented by many economists.  

Here are some critical ones that Prof. Roubini and Prof. Mihm wrote in their 2010 book "Crisis Economics". (Writing a review of this book, The New York Times described Prof. Roubini as someone known as "Dr. Doom" for accurately predicting the US housing burst and the consequent global recession two years in advance in 2006.)

Also Read: Rebooting Economy XII: Is private sector inherently more efficient than public sector?

First, the authors sought central banks to "enforce" existing regulations and powers to protect financial systems. They have plenty of powers to check "speculative manias from spinning out of control" but didn't use them in the run-up to the 2007-08 meltdowns.

They recommended that regulations should be consolidated in the hands of fewer, more powerful regulators. This is far more relevant for India and the US.

Second, to prevent overnight collapse of shadow banking entities, they suggested extending two existing facilities that prevent bank runs: (i) central banks to act as the lender-of-last-resort to shadow banks and (ii) deposit insurance for shadow banks to assure depositors that their money is safe.

Both these facilities became the global norms in the post-World War II order.  

The authors wrote that the first (lender-of-last-resort) was "available during the Great Depression, but the Federal Reserve (US) failed to use it effectively" and the second came in with the Franklin Roosevelt's New Deal. The rest of the world followed.

Also Read: Rebooting Economy XI: Why are private companies so prone to financial frauds?

The trouble is both these cost money. NBFCs would then be subjected to tight RBI regulations two important ones of which are: (i) maintaining certain levels of cash all the time, called Cash Reserve Ratio (CRR) - set at 3% for FY21 - and (ii) provisioning against NPAs - ranging from 15% to 100% depending on the period of defaults.  Both reduce cash available with NBFCs for lending and thereby, potential for profit.

Similarly, deposit insurance (Indian depositors are now insured for Rs 5 lakh) is a charge on banks and if adopted, would become a charge on NBFCs, further reducing cash availability for lending. These measures would also call for tighter financial reporting norms which all shadow banking entities seek to avoid.

These two facilities are relevant to India for another reason: 99.7% of NBFCs' funding is short-term (technically marked as EF2 function), as revealed by the RBI's Trend and Progress of Banking released in December 21, 2017 in India  and a perennial source of concern in hard times (like panic that spread during the 2007-08 and led to many bank runs).

For India's NBFCs, short-term means 1 to 3 years while long-term lending can go up to 20 years in case of housing and infrastructure projects, bankers aver.  

Globally, short-term funding (EF2) is not such a big deal, constituting just 7% of that of NBFIs in 2018, according to the FSB report of 2020.

There is a good case for changing this business model of NBFCs to reduce risks.

Third, controlling the excesses of complex, opaque and highly risky derivatives associated with a number of financial stress and crises, not just the 2007-08 meltdowns, spreading toxic assets across the financial system.

Last but not the least, as Prof. Roubini and Prof. Mihm mentioned, crises can't be abolished, they would reappear in new forms but they need not loom large or threaten economic existence by catching governments and regulators unprepared.

Also Read: Rebooting Economy X: COVID-19 puts question mark on private sector's efficiency in healthcare

Rebooting Economy XVI: How governments run shadow banking and risk financial stability

 That shadow banking was at the core of the financial sector meltdown that led to the Great Recession of 2007-08 is well documented and so is the fact that it remains big and powerful enough to cause serious financial crisis and yet, India and the US continue to promote it

Prasanna Mohanty | August 12, 2020 | Updated 20:48 IST

India saw the collapse of its own leading shadow bank, Infrastructure Leasing & Financial Services Limited (IL&FS) in September 2018

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The most shocking aspect of shadow banking entities world over is that these are run and promoted by governments and government-run entities to the detriment of regulatory oversights evolved over time to ensure financial stability.  

The shadow banking system "consists of financial institutions that look like banks, act like banks, and borrow and lend like banks, but - and here's the important part - are not regulated like banks". That is how Prof. Nouriel Roubini of the New York University described it in his book 2010 "Crisis Economics", co-authored with Prof. Stephen Mihm of the University of Georgia.

Prof. Roubini is also known as "Dr. Doom" for accurately predicting that the US housing bubble would burst, plunging the world economy into recession. Many other economists too had forewarned the same, but they were ignored, even ridiculed.

The centrality of shadow banking to the 2007-08 financial crisis is well documented. Prof. Roubini and co-author narrated how complex, dodgy, and risky housing mortgage-backed securities were bundled, sliced, and diced into different levels of credit risks and transmitted around the world, spreading toxic assets. They concluded, like many others: "It's little wonder that the shadow banking system was at the heart of what would become the mother of all bank runs."

Also Read: Rebooting Economy XV: Why shadow banking should worry policymakers in India and elsewhere

Economist Laura E Kodres of the International Monetary Fund (IMF) described shadow banking more colourfully, using the Duck Test, in her own analysis of shadow banking's central role in the 2007-08 crisis: "If it looks like a duck, quacks like a duck, and acts like a duck, then it is a duck - or so the saying goes. But what about an institution that looks like a bank and acts like a bank? Often it is not a bank - it is a shadow bank."

More than a decade later, nothing much has changed on the ground. Governments continue to promote them. Here are some examples, beginning with the US experience.  

US's official shadow banks: Fannie Mae and Freddie Mac

In September 2008, the US government took over Fannie Mae and Freddie Mac - two giant shadow banking entities operating in the US housing mortgage market.  

Both Fannie Mae and Freddie Mac went down under their own mountains of debts. At the time of their takeover, their combined debt stood at $5.4 trillion, which was "equal to the publicly held debt of the United States" and their market share in new mortgage stood at 80%, declared the official statement of the Federal Housing Finance Agency.

It was the US Congress that had created both Fannie Mae and Freddie Mac to operate in the secondary housing mortgage market. They are also known as government-sponsored enterprises (GSEs).  

Fannie Mae was set up in 1938 as a government entity and then handed over to the private sector in 1968. Freddie Mac was created in 1970 as a private entity to compete with Fannie Mae.

What does operating in secondary market mean?  

It means Fannie Mae and Freddie Mac did not offer housing loans or keep housing mortgages (primary housing market) themselves. They bought housing mortgages from original lenders, packaged them into extremely complex securities, and sold them to pension funds, insurance companies, and hedge funds, thereby spreading the risks all around. All this happened completely outside the regulated banking system.  

The official takeover statement mentioned "a significant supervisory concern" about Fannie Mae and Freddie Mac, their "deteriorating credit mortgage environment" (little scope of mobilising credit or cash from market) and concluded that these two "cannot continue to operate safely and soundly and fulfill their public mission".

These two are classic examples of public sector building private sector as well as inefficiency of the latter.

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Ironically, Fannie Mae was created during the 1929 Great Depression-era - which had also been triggered by collapse of the US housing finance sector and market was unwilling to lend. Fannie Mae was supposed to fill this gap.  

Seventy years later, in 2008, Fannie Mae was at the core of engineering the 2007-08 financial crisis and found no source of funding, forcing the US government to bail it out. It was a highly successful government-run entity for 30 long years before being handed over to the private sector in 1968.  

Freddie Mac, too, was set up by the US Congress, in 1970, to operate in the same secondary housing mortgage market outside banking oversight. But this was created as a private entity to compete with Fannie Mae. It collapsed too and found the market unwilling to bail it out or restore equilibrium. The US government then stepped in at the cost of taxpayers.

Who else is paying for the huge $5.4 trillion debt of these private sector shadow banks?  

India's official shadow banks: IL&FS and PFC  

India saw the collapse of its own leading shadow bank, Infrastructure Leasing & Financial Services Limited (IL&FS) in September 2018. The banking regulator RBI took over and initiated bankruptcy proceedings. At the time of takeover, its outstanding debt stood at Rs 91,000 crore, out of which Rs 57,000 crore was from banks, posing a high risk to derail the conventional banking system.

Who runs IL&FS?

It is a public-private partnership (PPP) entity.

Here is a statement from its official website: "IL&FS was incorporated in 1987, initially promoted by the Central Bank of India (CBI), Housing Development Finance Corporation Limited (HDFC) and Unit Trust of India (UTI). Over the years, we have broad-based our shareholding and inducted institutional shareholders including State Bank of India (SBI), Life Insurance Corporation of India (LIC), ORIX Corporation Japan, and Abu Dhabi Investment Authority (ADIA)."

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The official website also says that it is "one of India's leading infrastructure development and finance companies" and "pioneer of Public-Private Partnership (PPP) in India".  

In 2019, the RBI found that IL&FS had not disclosed bad debts for four years until FY19 and that 70% of its total loans and advances by March 31, 2018, were non-performing assets (NPAs).

On May 30, 2019, the Serious Fraud Investigation Office (SFIO) filed a charge sheet in a special court in Mumbai, blaming the RBI for inaction even when the banking regulator had detected financial frauds in IL&FS Financial Services Ltd (IFIN), a subsidiary of IL&FS in 2015, 2016 and 2017, but allowed it to continue to operate.  

Subsequently, the RBI clarified that it had given IFIN time until 2019 to clean up its books.

On July 22, the National Financial Reporting Authority (NFRA), a new regulatory authority set up in 2018, debarred IFIN's auditor former Deloitte India CEO Udayan Sen, for seven years and imposed a penalty of Rs 25 lakh for financial fraud, concluding that he "had been totally compromised". (For more read 'Rebooting Economy XI: Why are private companies so prone to financial frauds? ')

Here is something interesting about IL&FS's organisational structure.

The government provided lists of IL&FS's group companies to the National Company Law Tribunal (NCLT), which the latter reproduced in its interim order of March 12, 2020.

The government list named 302 IL&FS group entities - 169 incorporated in India and 133 outside India - a veritable industry of their own.  

The government has not been found wanting to indirectly run shadow banking either.

One is the Power Finance Corporation (PFC), declared as "Navratna CPSE" by the government in 2007.  

Its official website says: "Incorporated on July 16th, 1986, Power Finance Corporation Ltd. is a Schedule-A Navratna CPSE, and is a leading Non-Banking Financial Corporation (NBFC) in the Country... PFC is under the administrative control of the Ministry of Power... conferred the title of a 'Navratna CPSE' in June 2007 and was classified as an Infrastructure Finance Company by the RBI on 28th July 2010."

It tops the list of Indian companies in debts - Rs 5.25 lakh crore in FY19 - a 180% rise in five years.

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At number 4 is its own subsidiary Regional Electrification Corporation (REC), also a PSU, with a 52.53% stake. REC has an outstanding debt of Rs 2.44 lakh crore in FY19 - a 69% rise in five years.

IL&FS and PFC are not the only examples. Dewan Housing Finance Corporation Ltd (DHFL), another NBFC, went down in 2019 under its mounting debts, defaulted, and was taken over by the RBI. The bankruptcy proceedings have also been initiated in this case.

Several other NBFCs were found to be in deep in 2019: Reliance ADAG Group companies like Home Finance and Reliance Commercial Finance; Indiabulls Housing Finance, Edelweiss Financial Services, Piramal Capital, Karvy Stock Broking Ltd (KSBL), etc. (For more read 'Reality Check: Stress in NBFCs shows no sign of abating ')

That NBFCs are vulnerable and pose a serious threat to the economy ever since IL&FS went down has been recognised by the RBI's latest Financial Stability Report released on July 24, 2020.

This report said: "In the aftermath of the IL&FS crisis, NBFCs have been facing differentiation in market access and financial conditions, with only the higher rated entities able to raise funds. They have also started maintaining liquidity cover of two to three months, despite the higher costs. In the context of COVID-19, however, risks to the sector and consequently, systemic risks can intensify."

RBI's superficial claims of NBFC oversight

The RBI claims that it regulates NBFCs and hence even though these are classified as shadow banking by the global watchdog Financial Stability Board (FSB) set up in 2011, these (NBFCs) are "distinctly different" from shadow banks. The RBI is very much a part of the FSB mechanism.

The RBI's October 2017 Bulletin, on which the FSB's January 2020 report relied to analyse India's shadow banking sector, says: "NBFCs are, however, distinctly different from shadow banking entities in other countries. They are regulated by the Reserve Bank of India (RBI), with priority being assigned to calibrating regulations to harmonise them with those of the banking sector regulations to minimise the scope of regulatory arbitrage."

But the FSB's 2020 report made no such allowance or acknowledged it either. Its descriptions of the high-risk shadow banking segment, called Non-Banking Financial Intermediation (NBFI), perfectly matches the functioning of NBFCs as listed by the RBI itself in its December 2019 Report on Trends and Progress of Banking in India.

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Nor the RBI's claim is backed by evidence in the case of IL&FS (SFIO report nailed it as mentioned earlier) or DHFL.  

In fact, RBI Governor Shaktikanta Das admitted in an interview in December 2019 that "NBFC regulation is not as strong as (in) banks". Addressing a bankers' convention on July 11, 2020, he further declared that the RBI would extend principles of good governance to "large-sized NBFCs in due course".

There is nothing new in such statements and the "due course" has been very long in coming.  

In 2014 the RBI issued a statement precisely saying what Das had recently said: NBFCs are not subjected to tougher rules applicable to banks and that regulations on NBFCs would be tightened.

The statement came in the wake of NPA scare holding back conventional banks while NBFCs started lending heavily, causing further concerns about spreading financial risks. (For more read 'Reserve Bank tightens rules for NBFCs, raises minimum capital requirement' )