The Risk of Implicit Guarantees: Evidence from Shadow Banks in China

35 Pages Posted: 13 Jun 2019

See all articles by Ji Huang

Ji Huang

The Chinese University of Hong Kong (CUHK) - Department of Economics

Zongbo Huang

The Chinese University of Hong Kong, Shenzhen

Xiang Shao

Fudan University - School of Management

Date Written: May 29, 2019

Abstract

Although implicit guarantees are widely used in the shadow banking system, we know very little about its qualitative and quantitative properties. In this paper, we use a micro-level data set on China's shadow bank products to quantify the risk of implicit guarantees. We find a robust empirical fact that a bank extends stronger implicit guarantees to its shadow bank debt (i.e., wealth management products) when its reputation deteriorates. A simple model based on a stylized signaling game is proposed to rationalize the fact. The key mechanism of the model is that as a bank's reputation becomes worse, it has stronger incentives to send positive signals to the market, i.e., to boost the realized returns of its shadow bank debt, although it is not obliged to do so. Our findings imply that riskier banks should have higher risk-weight for their off-balance-sheet exposure because they are more tempted to offer implicit guarantees and take losses for its off-balance-sheet operations.

Keywords: shadow banking, implicit guarantees, off-balance-sheet financing

JEL Classification: G21, G23, G28

Suggested Citation

Huang, Ji and Huang, Zongbo and Shao, Xiang, The Risk of Implicit Guarantees: Evidence from Shadow Banks in China (May 29, 2019). Available at SSRN: https://ssrn.com/abstract=3395598 or http://dx.doi.org/10.2139/ssrn.3395598

Ji Huang (Contact Author)

The Chinese University of Hong Kong (CUHK) - Department of Economics ( email )

Shatin, N.T.
Hong Kong

Zongbo Huang

The Chinese University of Hong Kong, Shenzhen ( email )

Xiang Shao

Fudan University - School of Management ( email )

No. 670, Guoshun Road
No.670 Guoshun Road
Shanghai, 200433
China

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