Shadow Banking in China

Shadow Banking in China

Risk, Regulation and Policy

Wei Shen

This timely book investigates the dynamic causes, key forms, potential risks and changing regulation of shadow banking in China. Topics discussed include P2P lending, wealth management products, local government debts, and the underground lending market. Taking policy considerations into account, the author provides a comprehensive analysis of the regulatory instruments tackling the systemic risks in relation to China’s shadow banking sector. Central bank’s role, interest rate formation mechanism, exchange rate reform and further deepening reform of the regulatory regime and financial markets are also thoroughly discussed in the context of China’s continuing financial reform.

Chapter 13: Is China’s new deposit insurance scheme a panacea? A functional analysis

Wei Shen

Subjects: asian studies, asian politics and policy, economics and finance, asian economics, financial economics and regulation, law - academic, asian law, finance and banking law, regulation and governance

Extract

In the aftermath of the latest global financial crisis, there has been a surging shadow banking sector both in China and abroad. An econometric analysis demonstrates some market forces behind this growth of shadow banking: tight banking regulation, low interest rates and investment return rates, limited channels for funding, and a large institutional demand for assets. These are the common factors China shares with other economies. What is unique about China’s shadow banking is its highly repressed financial market and system in which banks and state-owned sectors possess a much more predominant and monopolistic position in terms of allocation of financial resources and assets. The institutional infrastructure, including the interest rate and exchange rate formation mechanism as well as monetary policies, has been put in place to facilitate this financial repression strategy. While this strategy has successfully secured a stable and less expensive source of funding to sustain economic growth, it also distorts the supply and demand sides. As a result, the market response is to create a shadow banking sector to fill in this gap between supply and demand. Defining (the scope of) shadow banking is not merely an academic exercise. It is highly relevant to regulatory design and regulatory efficacy. While there is not a uniform definition of shadow banking accepted by both regulators and academics, some attempts have been made to clarify the understanding of shadow banking. A break-down approach is often adopted to set the boundaries for shadow banking. For example, the Financial Stability Board (FSB) breaks the shadow banking system down into three sectors and nine subsectors, that is, the fund-related sector (money market funds, hedge funds and other investment funds), country-specific sector (Dutch special financial institutions, US funding corporations, and US financial holding companies), and finance-type sector (broker-dealers, finance companies, and structured finance vehicles). The commonality of these sectors and subsectors is their financial intermediary function and non-bank characteristics, which differentiate them from banks and financial institutions. This is also the reason that the FSB term them as “other financial intermediaries”. Apart from its technical value, the FSB’s way of drawing the boundary of shadow banking has a limitation. It may overlook the domestic conditions each country has in its financial market.

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