Role of Non-Bank Financial Intermediation: Challenges for Central Banks in the SEACEN Countries

A well developed non-bank financial sector is viewed as an important component of a healthy and efficient financial system that can provide a sound base for growth and prosperity in the economy. This study observes that the non-bank financial sector has developed significantly in the SEACEN countries in the last two decades and it has helped widen and deepen the financial systems in these countries. The degree and scope of non-bank financial intermediation varies in the SEACEN region according to the extent of development of the financial systems. In more developed financial systems like those of Korea, Taiwan, Singapore, Malaysia, Thailand, and Philippines, the non-bank financial intermediation has reached the maturity stage while in the less developed financial systems of Sri Lanka and Nepal, such intermediation is still in the growing stage. Various types of non-bank financial institutions (NBFIs) are operating in the SEACEN countries. Finance companies, development financial institutions, merchant banks, insurance companies and pension funds are the major types of NBFIs found in almost all the SEACEN countries. There has been a remarkable decline in the number of NBFIs in Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand during the last decade, specifically after the financial crisis of 1997 while all types of NBFIs have been constantly growing in Sri Lanka and Nepal. The market share of NBFIs in the SEACEN countries range between 15 and 43 percent in terms of assets, between 7 and 33 percent in terms of deposits, and between 9 to 27 percent in terms of loans. The overall performances of NBFIs show that the non-bank financial intermediation occupies a significant position in the financial system in the SEACEN region. Monetary policy can be transmitted to a wider section of the economy through the activities of NBFIs as they integrate the scattered economic units to the national economy. Another positive effect of the non-bank financial intermediation in the conduct of monetary policy is the change brought by it in the deposit structure in the economy. NBFIs have induced a change in the deposit structure in the SEACEN countries and thus made more funds available for loans. This is because of the low or no reserve requirement imposed on NBFIs. Major challenges posed by the non-bank financial intermediation in the conduct of monetary policy include the likely pressure induced in the interest rate, reduced effectiveness of credit control, and the reduced reliability of monetary aggregates as intermediate policy targets. NBFIs offer attractive interest rates normally above those of banks and the banks may also increase their interest rates to compete in the market. Such pressure may reduce the effectiveness of policy induced interest rate changes. On the other hand, when a central bank wants to reduce the volume of credit by increasing the reserve ratio, the effect of such intervention is partially offset by the amount of non-bank credit as NBFIs are subject to low or no reserve requirement. Similarly, with the growing level of non-bank financial intermediation, the appropriateness of monetary aggregates as intermediate target has been reduced markedly in the SEACEN countries. The main reason for such reduced attractiveness of the monetary aggregates is the complete or partial exclusion of the activities of NBFIs in the compilation of these aggregates. These facts reveal that the growing level of non-bank financial intermediation has complicated the conduct of monetary policy in the SEACEN countries. Non-bank financial intermediation can add to the health and stability of financial system by making it complete, balanced and sophisticated. NBFIs supplement the role of commercial banks in providing financial services in the economy by serving the section of population generally not covered by banks, help improve the operational efficiency through enhanced competition in the market and improve the resilience of the financial system. Non-bank financial intermediation also brings some challenges to the stability of financial system, mainly arising from their inadequate supervision. Inadequately supervised NBFIs may pose a threat to the stability of the financial system. High risk investments, high credit-deposit ratio and higher level of nonperforming assets of NBFIs increase volatility in the financial system. Despite some problems posed in the conduct of monetary policy and financial stability, NBFIs are still the important players in the financial system in the SEACEN countries. NBFIs play both a supplementary and competing role in the financial market. In the recent years, the competing portion has been more pronounced. Therefore, they should be motivated to focus more on their supplementary role. As most of the problems associated with non-bank financial intermediation arise from the inadequate supervision of NBFIs, they should be brought under the supervision of some competent agencies while ensuring that their intermediary role be not adversely affected. The recent restructuring of financial landscape has led to the merger, upgrading and even closure of various types of NBFIs in the majority of the SEACEN countries. This may reduce financial intermediation and the access of certain sections of the population to financial services. Therefore, reforms and restructuring should ensure that NBFIs continue their intermediary roles. The growing unreliability of the monetary aggregates occurs when the information not included in them becomes significantly large. Monetary aggregate targeting may still be an effective monetary policy framework provided that the aggregates contain complete information. In this regard, in the countries still adopting the monetary targeting framework, a gradual shift to use even broader monetary aggregates could be planned rather than switching to a completely different monetary policy regime.