Shadow banking has always played a part in India and China to meet credit needs not catered to by the formal banking sector. This article argues that financial liberalisation and deregulation have seen shadow banking institutions in both countries becoming more interconnected and more systemically important. India and China require better regulatory supervision based on the functions of shadow banks to reduce any scope of regulatory arbitrage even if this is at the cost of lower economic growth. Prudential regulation like Basel III is not of much help. What is required is better structural regulation of shadow fi nancial institutions to curb their explosive growth.
