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.

In the global financial markets, many financial institutions that act like banks are not supervised like banks. But in Bangladesh, non-banking financial institutions (NBFIs) recently have emerged as alternative lenders to the banks.

NBFIs are not banks but are strictly regulated by Bangladesh Bank, providing multiple alternatives to transform an economy's savings into capital investment and remain unhurt during the global financial crisis. So, can you call the NBFIs shadow banks?

This is a burning question raised recently by the CEOs of many non-banking financial institutions (NBFIs), who are now financing big infrastructure projects, and industries through syndications and even provide loans to SMEs, and women entrepreneurs at very low rates, like commercial banks.

While banks may offer a set of financial services as a package deal, NBFIs unbundle these services, tailoring their services to particular groups as they are specialized in some particular areas. By this unbundling, targeting, and specializing, NBFIs promote competition within the financial services industry. So, former Fed chairman Alan Greenspan lauded their roles in strengthening an economy, as they provide "multiple alternatives to transform an economy's savings into capital investment [which] act as backup facilities should the primary form of intermediation fail."

Economists say, a market-based financial system has better-developed NBFIs than a bank-based system, which is conducive for economic growth. A multi-faceted financial system that includes non-bank financial institutions can protect economies from financial shocks and enable speedy recovery when these shocks happen.

Non-bank financial intermediaries recently have gained global attention as they have played an important role in bridging the funding gap created when banks scaled back lending after the 2008 financial crisis. In Bangladesh, the picture is similar, in some cases more definite. So, when we talk about the country's shadow banking asset growth, it is the growth of NBFIs, as they are the main driver of this growth in Bangladesh. But they are not like the shadow banks defined by global regulators thanks to a more stringent regulatory environment which kept them safe during the crisis.

The phenomenon growth of NBFIs in recent years has pushed up shadow banking assets, which globally shot up to $80 trillion in 2014 up from $26 trillion more than a decade earlier. This has drawn regulatory attention to redefining the roles of NBFIs and other new financial services like mobile financial services (MFSs), which brought to global banks USD 1.3 trillion or 34 per cent of their global profits in 2014, is moving fast to titans like PayPal in the shadow banking.

Recovering from the black eye it received during the dark days of the financial crisis, the unregulated shadow banking system continues to gather both assets and attention, the latter from industry insiders who believe the climate is right for strong growth ahead. But the risks associated with shadow banking are still in the regulatory debate.

In Bangladesh, NBFIs and MFSs are under scrutiny due to several factors including risks and security, costs and competition, regulations and supervision. The boat is ready but many things are yet to be unsettled to sail it.

So, many see the shadow banking at a crossroads. The big question is: Where to go from here?

To define the destination of shadow banking in Bangladesh, we should bring the NBFIs and the MFSs under the spotlights, which are the main drivers of shadow banking growth.

What Is Shadow Banking?

So, let's see what is shadow banking.

The IMF calls it "one of the many failings of the financial system." But Daniel K. Tarullo, a member of the Board of Governors of the Federal Reserve System sees "appropriate monitoring of shadow banking and the application of appropriate policy responses, where necessary, helps to mitigate the build-up of such systemic risks.

Shadow banking, in fact, symbolizes one of the many failings of the financial system leading up to the recent global crisis. The term "shadow bank" was coined by economist Paul McCulley in a 2007 speech at the annual financial symposium hosted by the Kansas City Federal Reserve Bank in Jackson Hole, Wyoming. In McCulley's talk, shadow banking had a distinctly US focus and referred mainly to nonbank financial institutions that engaged in what economists call maturity transformation.

Commercial banks engage in maturity transformation when they use deposits, which are normally short-term, to fund loans that are longer-term. Shadow banks do something similar. They raise (that is, mostly borrow) short-term funds in the money markets and use those funds to buy assets with longer-term maturities. But because they are not subject to traditional bank regulation, they cannot-as banks can-borrow in an emergency from the Federal Reserve (the U.S. central bank) and do not have traditional depositors whose funds are covered by insurance; they are in the "shadows."

Politicians and economists who often have little in common, unanimously agree that shadow banking, left to its own devices, has the potential to trigger another financial collapse. For example, Janet Yellen, Federal Reserve's chair, has admitted that shadow banks pose "a huge challenge" to the world economy, while Hillary Clinton called for tough measures to contain the global bogeyman.

But many analysts, like Daniel K. Tarullo of the American central bank, see nonbank lenders may be better positioned to offer financial services to consumers that banks cannot, while other nonbank intermediaries can expand the availability of capital-benefits that may outweigh some of the risks. This has led global regulatory authorities to put the spotlight on non-banking operations, governance, liquidity management and most of all, linkages with the banking system.

The question is what form it should take and which regulator should make the necessary risk-benefit analysis. And certainly, the answer to this question will define the way of shadow banking- where to go from here.

* Market Trends

The global assets of the shadow banking industry grew by $1.1 trillion to about $36 trillion in 2014, outpacing banks and other financial institutions, according to the latest Report of the Financial Stability Board(FSB). "Still, the rise in shadow banking isn't always a negative. In many countries monitored by the FSB, a growth in shadow banking coincided with economic expansion", the FSB said in its latest report.

But the growth and success of shadow banks will begin to modestly slow in 2016 as regulators step up scrutiny of the sector and banks weigh competitive responses, according to Fitch Ratings. Shadow banks are increasingly likely to become victims of their own success, which will translate into incrementally slower growth, increased operating costs and the beginning of a gradual convergence with the very banks they are aiming to disintermediate.

Fitch also thinks that banks will lobby for increased regulation of shadow banks, either overtly or discreetly, based on their growing size, interconnectedness and, in certain instances, consumer-facing nature. According to Fitch, this would be a relatively basic way for banks to potentially chip away at shadow banks' competitive advantages.

Fitch expects traditional banks to continue their collaborative approach with shadow banks, at least in the near term, partnering with or lending to them, as a means of participating in their success and gaining technological and strategic intelligence.

While this facilitates the growth of a competitor, it allows traditional banks to participate in a potential growth opportunity without attracting the same levels of typical regulatory scrutiny. These partnerships could also provide traditional banks with valuable intelligence on the evolving "fintech" landscape, which could inform their competitive responses over the longer term.

"With or without the prodding of banks, Fitch expects regulators to continue to sharpen their focus on shadow banking in 2016, if for no other reason than that shadow banks are increasingly large, rapidly growing and demonstrate less transparency than their bank peers, all of which are historical red flags for potential systemic risk".

At a minimum, heightened regulation could result in increased reporting and compliance burdens that could dampen shadow banks' profitability. More comprehensive regulatory changes, such as minimum capital requirements, caps on interest rates or limits on the use of bank intermediaries, could have more disruptive effects on certain shadow banks' business model, says Fitch.

Spot Light: Non Banking FIs

In Bangladesh, NBFIs have grown rapidly over the years both in terms of assets and size as the economy maintained stable growth despite global financial crisis. Adequate policy support and necessary regulatory measures can boost the regulated NBFI sector to stimulate economic growth. The growth of NBFIs was more than 15 per cent annually over the years, industry sources said.

Globally, NBFIs and non banking services are identified as shadow banks as they are involved in activities outside the formal regulation, cannot take deposits and avail central bank's support. But in Bangladesh, the situation is different to some extent- NBFIs are working under the regulatory guidelines and close supervision of Bangladesh Bank and can take deposit from private and public sector. There are 33 NBFIs are now struggling to survive in the competitive bank dominated financial sector.

As commercial banks are showing reluctance to long term financing, NBFIs are now increasingly coming forward to provide credit facilities for meeting the diversified demand for investment fund in the country's expanding economy. They are now useful and successful for the evolution of a vibrant, competitive and dynamic financial system in the money market and growing as alternative lenders to the banking institutions under a prudent risk management framework and close supervision of Bangladesh Bank (BB).

NBFIs have innovated over time and found ways to address the debt requirements of the economy from large infrastructure to small micro enterprise. They meanwhile, have also responded positively to regulatory efforts to better understand risks and evolved from being fragmented and informally governed to being well regulated and in many instances, adopted best practices in technology, innovation and risk management but not in governance practices.

The reason is that the NBFIs came into the regulatory focus in recent time. Learning lessons from the global crisis, BB has taken measures to address and manage the risks in more prudent and organized way. Since 2000, BB has issued five core risk management guidelines, namely Asset-Liability Management (2005), Credit Risk Management (2005), Internal Control and Compliance Framework (2005), ICT Security (2010), and Prevention of Money Laundering and Terrorist Financing (2012).

BB also issued several measures a guideline on Environmental Risk Management for NBFIs in 2012, Prudential Guidelines on Capital Adequacy and Market Discipline for Financial Institutions (2011), Stress Testing (2012) and Guidelines on Products and Services of Financial Institutions in Bangladesh (2013). Lastly, BB issued DFIM circular where NBFIs are instructed to prepare and submit a comprehensive risk management paper on monthly basis.

But NBFIs are struggling to survive driven by high costs of funds, weak governance, uneven competition from banks, dearth of skilled professionals and lack of a level playing field in absence of regulatory support and absence of a well functioning financial market.

* Cost of funds

The cost still continues to plague the NBFIs since the perception of the general people still continues to favor the banks against non banks. With high cost of funds, non-banks are forced to compete with the banks those have relatively low cost of funds. This situation has been aggravated due to absence of a well functioning financial market, which can facilitate them to borrow money at competitive market rate. To reduce dependency on bank funds, some of financial institutions have already introduced new financial instruments like bonds, asset securitization. But lack of a well functioning financial market including an efficient and transparent call money market and sound, vibrant secondary market for bonds is impeding the NBFI industry growth.

* Corporate governance

Poor governance issue still plagues the NBFI operations which has become a great concern for their growth. Bangladesh Bank recently has found massive irregularities in the operations of some NBFIs, which is very risky for the financial system. The former Governor of Bangladesh Bank recently disclosed that Tk 700 crore had been drained out by a former chairman of a NBFI in names of his family members violating the rules. Some directors are engaged in day to day operations, which forces some CEOs to operate businesses by passing the central bank's policy.

Governance, like regulation, is an evolving concept and is continuously fine tuned to suit the dynamic economic and business environment. While regulation is imposed from outside, corporate governance is internal and is more in the nature of self regulation which ensures that the principles and rules laid down by the regulations are scrupulously adhered to. So, both regulators and market players should come forward to ensure good governance practice in NBFIs. Prior to the global crisis, the emphasis was increasingly on self regulation through robust corporate governance so that the regulation could remain largely principle based and less prescriptive.

Spot Light: Mobile Financial Service

Bill Gates once said that banking will always be needed but banks as we know them could easily disappear. Banking is changing, innovations is emerging. New entrants to the market, new business models, changing customer expectations and fragmentation of traditional services are all contributing to put traditional banks under pressure.

Many experts say banks are heading for a bleak future as people have already started storing their money outside the banking sector and making payments that are not tied to a formal bank account. The threat to banks from such novel payment systems is pretty clear in poor and developing countries like Bangladesh. Payment business brought to banks USD 1.3 trillion or 34 per cent of their global profits, according to McKinsey. The new landscape has put a severe blow on the brick-and-mortar banks all over the world. Bangladesh is no exception.

With the financial crisis all but negotiated, banks and regulated non-banking companies may be looking forward with optimism at long last. However, reports from McKinsey and Deloitte suggest that the next big challenge - the impact of fintech firms - needs their imminent attention.

Mobile Financial Services (MFSs) are an integral part of the financial system in Bangladesh. Three MFSs bkash, DBBL Mobile Banking and Islami Bank m-Cash are now leading the market with more than 60 per cent of the market share with bCash, while the central bank provided 10 licenses to banks to offer the full range of mobile financial services. The bKash service is provided by BRAC Bank, while Dutch Bangla Mobile Banking of Dutch Bangla Bank and Islami Bank m-Cash of Islami Bank Bangladesh Limited are fully bank-led models.

All MFSs are now operating businesses under the central bank's guidelines on "Mobile Financial Services for Banks" issued in 2011 which clearly states a choice to make the market bank-led. However, the central bank has advocated for mobile operators and microfinance organizations to be active partners.

But the risks and security associated with this new player of the market is now a hot topic in Bangladesh financial hubs following the recent ATM scams with some private banks' booths and the cyber attack on Bangladesh Bank's reserve by a foreign gang of cyber criminals who stolen $101 million from its nest account.

Risks & Security

Market analysts say the success of NBFIs and MFSs is mostly depends on their ability to contain risk, adapt to changes and tap demand in markets that are likely to be avoided by the bigger players. In the absence of effective financial regulations, non-bank financial institutions can actually exacerbate the fragility of the financial system, while inadequate security measures in payment system can diminish the trust of customers.

Since not all NBFIs are heavily regulated, the shadow banking system constituted by these institutions could wreak potential instability. A prime example would be the 1997 Asian financial crisis, where a lack of NBFI regulation fueled a credit bubble and asset overheating. When the asset prices collapsed and loan defaults skyrocketed, the resulting credit crunch led to the 1997 Asian financial crisis that left most of Southeast Asia and Japan with devalued currencies and a rise in private debt.

So, a stable regulatory environment will provide opportunities for NBFIs and MFSs to continue to grow in the financial ecosystem and create meaningful financial inclusion and employment opportunities in the remote corners of the country.

The recent ATM scams with some private banks' booths and the ongoing concern over the cyber attack on Bangladesh Bank's reserve have made both market operators and regulators about the future challenges in mobile financial services in the country. And the following questions have been raised by many:

Is the central bank capable of monitoring transactions through mobile phone devices? Are the customers' interests protected by the MFS providers under the non-bank model? Should CEOs depend on foreign IT service providers, who keep data outside the national boundary to make money for them?

And certainly, the answers to the above questions will define the destination of NBFIs and MFSs to shine the shadows, I am sure.