Optimal Shadow Banking

54 Pages Posted: 20 Apr 2021 Last revised: 23 May 2022

See all articles by Zehao Liu

Zehao Liu

School of Finance, Renmin University of China

Ting Yang

North China University of Technology

Jinfan Zhang

Chinese University of Hong Kong (Shenzhen)

Date Written: May 23, 2022

Abstract

In contrast to most countries, China’s shadow banking system has experienced explosive growth since the 2007-09 global financial crisis with the tacit endorsement of the regulator. We develop a model to understand this puzzling phenomenon. Our model shows that in the presence of local governments’ intervention on bank loans towards low-quality projects, the policy combination of tightening formal banking sector credit, while loosening shadow banking sector can contain low-quality project financing without causing credit crunch. Since shadow banking assets are less diversified than commercial banks, shadow banking is subject to higher funding liquidity risk, which provides incentive for banks to contain high-risk projects in shadow banking system. In support of our theory, we indeed find empirical evidence that, when on-balance-sheet financing is constrained, banks shift high-quality, rather than low-quality credit, into their sponsored shadow banking system.

Keywords: Shadow Banking, Information Production, Moral Hazard, Bank Regulation, Financial System in China

JEL Classification: E40, E50, G20

Suggested Citation

Liu, Zehao and Yang, Ting and Zhang, Jinfan, Optimal Shadow Banking (May 23, 2022). Available at SSRN: https://ssrn.com/abstract=3830240 or http://dx.doi.org/10.2139/ssrn.3830240

Zehao Liu (Contact Author)

School of Finance, Renmin University of China ( email )

Ming De Main Building
Renmin University of China
Beijing, Beijing 100872
China

Ting Yang

North China University of Technology ( email )

Jinyuanzhuang No.5, Shijingshan District, Beijing
Beijing
China

Jinfan Zhang

Chinese University of Hong Kong (Shenzhen) ( email )

Shenzhen
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
138
Abstract Views
507
rank
285,844
PlumX Metrics