Shadow Money, Banking Competition and Stability: Evidence from China

62 Pages Posted: 23 Jul 2020

See all articles by Feng Xu

Feng Xu

Tianjin University - College of Management and Economics

Eva Lütkebohmert

University of Freiburg, Institute for Economic Research

Yajun Xiao

University College Dublin (UCD)

Date Written: August 23, 2019

Abstract

We study how competition for shadow money impacts banking stability. In our model, banks
compete for insured depositors and uninsured shadow money investors and default endogenously.
We estimate and calibrate our model to the Chinese banking sector and we find that shadow money investors are run-prone while depositors are not. Multiple equilibria emerge and may lead to severe financial distress with large welfare losses. Negative shocks to assets underlying shadow money amplify financial fragility. Furthermore, rollover costs can cause runs on shadow money. Imposing capital requirements on shadow money improves banking stability, but the effectiveness is limited.

Keywords: banking competition, bank runs, financial stability, shadow funding, wealth management products

JEL Classification: E44, G01, G21, G28, G32

Suggested Citation

Xu, Feng and Lütkebohmert, Eva and Xiao, Yajun, Shadow Money, Banking Competition and Stability: Evidence from China (August 23, 2019). Michael J. Brennan Irish Finance Working Paper Series Research Paper No. 19-9, Available at SSRN: https://ssrn.com/abstract=3313226 or http://dx.doi.org/10.2139/ssrn.3313226

Feng Xu

Tianjin University - College of Management and Economics ( email )

NO.92 Weijin Road
Nankai District
Tianjin, 300072
China

Eva Lütkebohmert

University of Freiburg, Institute for Economic Research ( email )

Platz der Alten Synagoge 1
Freiburg, D-79098
Germany

Yajun Xiao (Contact Author)

University College Dublin (UCD) ( email )

Belfield, Dublin 4 4
Ireland

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