Shadow banking places its bets on Jio India.

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The paths of financiers, particularly those not relying on state-backed deposits, are now starting to diverge within these neighboring economies.

Diverse Paths of Shadow Banking: India’s Jio Gains Momentum, China Faces Setback

The landscape of shadow banking is far from uniform. As seen in China, where nonbank lenders encounter liquidity strains due to their associations with troubled property developers, India’s counterparts are gearing up for growth.

In neighboring economies, the trajectory of financial institutions, particularly those operating beyond state-insured deposits, is taking distinct directions. In India, the emergence of Mukesh Ambani’s Jio Financial Services Ltd. on the stock market was marked by its spin-off from Reliance Industries Ltd., Ambani’s flagship company. On its debut, the stock experienced a 5% decline, with uncertainties surrounding the prospects of this nascent venture. Nonetheless, the substantial valuation of $19 billion implies high investor expectations.

Attention turns toward the pace set by Bajaj Finance Ltd., the current market leader whose value surpasses that of its untested rival by 2.5 times. Established almost four decades ago, Bajaj Finance aims for a 29% to 31% increase in assets during the current financial year. Combined with Jio, these entities hold a higher value than State Bank of India, the largest deposit-accepting institution in the country.

This divergence is strikingly evident in contrast to China. The phenomenon of shadow banking gained momentum in the People’s Republic in 2010 when Beijing grew wary of a credit bubble, which was inflated to shield the economy from the Global Financial Crisis. Chinese banks circumvented ensuing regulatory pressures by investing in beneficial interests within trusts, labeling them as “amounts due” or “financial accounts available for sale,” anything but loans that necessitate capital.

These trusts, attracting funds from affluent investors and corporate treasuries, extended loans to local government entities, property developers, and borrowers otherwise excluded from traditional credit channels. Although Chinese banks have reduced their involvement in such products in recent years, the real estate slump poses a threat to their nonbank issuers.

As noted by my colleague Shuli Ren, a trust product can reach maturity before the residential projects it financed are completed or sold. Concerns stemming from multiple defaults by Zhongrong International Trust, the first to issue overseas bonds, have triggered global investor worries about a potential contagion risk, although such concerns might be overstated.

India, too, experienced a severe shadow banking crisis five years ago. Following the 2018 collapse of the IL&FS Group, which served as a backer, owner, and operator of infrastructure assets, credit to real estate developers nearly dried up. The ensuing bankruptcy cascade saw even Housing Development Finance Corp., India’s major specialist mortgage lender, merging with its offspring, HDFC Bank Ltd., a deposit-taking institution.

However, that turbulence has subsided. The rapidly digitizing consumer economy is opening new avenues for growth for financial institutions, particularly those embracing a fusion of “fin” and “tech.” While bank deposits remain stagnant at the bottom of the pyramid, nonbanks can tap into the excess savings of affluent households and companies in pursuit of higher yields. In a hypothetical optimistic scenario examined by Investec Securities, Jio Financial could assemble a loan portfolio of up to 1 trillion rupees ($12 billion) by 2030, yielding a 6.5% return on assets.

With prudent leverage, this could translate to a return on equity of around 25%, a feat already achieved by Bajaj with over $32 billion in assets. Few banks of similar size worldwide exhibit such profitability.

The driving force behind this boom? Data. Bajaj initially embarked on financing two- and three-wheelers produced by the family’s primary firm. Ambani, in contrast, benefits from a shorter starting point. As India’s largest retailer and operator of its largest telecom company, he has been at the forefront of the digitization wave, which he now seeks to capitalize on.

Furthermore, Ambani leverages the cash flows from his established petrochemicals business to venture into diverse domains, including affordable phones, laptops, and his own brand of consumer products. Every link in his extensive supply chain involves small enterprises in need of financing. Consumers now aspire to buy and defer payment. Bill settlement in India is heavily digital, thanks to the Unified Payments Interface, a smartphone-based public service. Integrating credit is the next logical step. The indigenous Paytm app facilitated over $600 million in third-party loans on its platform just last month, marking a 148% annual surge.

Could Jio Financial become India’s equivalent of Ant Group Co., a scaled-down version of Jack Ma’s colossal entity in China? This prospect remains plausible. It might even surpass Ant, becoming a more astute observer of consumer behavior. The world never witnessed Ant’s zenith, as its Hong Kong IPO was abruptly shelved in 2020. Following regulatory demands to open its payments app to competitors and sever “improper links” steering users toward more profitable services like lending, Ant lost its exceptional status.

India’s regulatory stance toward national champions is likely to be more benevolent in comparison. While both nations’ financial systems have been bank-dominated, India’s unfolding future may lessen the significance of deposit-taking institutions, particularly smaller government-controlled lenders lacking technological prowess. They could potentially serve as liquidity providers, vying for lending opportunities with successful online platforms merely to offer competitive rates to savers.

As long as India’s shadow banks prudently avoid becoming entangled with a single asset class like real estate, there appears to be no insurmountable obstacle on the horizon.

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