Shadow Banking: China's Dual-Track Interest Rate Liberalization
56 Pages Posted: 14 May 2015 Last revised: 12 Jun 2018
Date Written: June 2018
We provide a novel interpretation of shadow banking in China from the perspective of dual-track interest rate liberalization. Shadow banking leads to Kaldor-Hicks improvement, if the gains from reducing the capital idleness---due to ultra-high reserve requirement ratio---and from financing the private enterprise (PE)---with higher productivity than the state-owned enterprise (SOE)---outweigh the expected PE default loss. Pareto improvement is achieved, as the SOE participates and gains in shadow banking by transferring bank loan to the PE. In the presence of credit misallocation favoring the SOE, full interest rate liberalization does not guarantee Pareto improvement.
Keywords: Shadow banking, interest rate liberalization, dual-track reform, Kaldor-Hicks improvement, Pareto improvement
JEL Classification: G21, G23, G28, P21, P31, P34
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