Implicit Guarantees and the Rise of Shadow Banking: The Case of Trust Products

63 Pages Posted: 20 Sep 2021 Last revised: 15 Dec 2021

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Xian Gu

Durham University Business School

C. Wei Li

University of Iowa

Jun "QJ" Qian

Fanhai International School of Finance, Fudan University

Yiming Qian

University of Connecticut

Date Written: September 15, 2021

Abstract

A central feature of China’s shadow banking sector is the prevalence of implicit guarantees that investors come to expect for returns on risky investments. We develop a theoretical model and argue that project screening by financial intermediaries such as trust companies, accompanied by their implicit guarantees on project payoffs, can be the second best arrangement in funding risky projects. Using a comprehensive set of investment products sponsored by all the licensed trust companies, we document evidence consistent with the model’s predictions about the ex ante pricing of the products and ex post recourse in case of defaults on the products. In particular, expected yields of the products not only reflect borrower risks, but also reflect the strength of implicit guarantees, including the characteristics of the issuing company and its controlling shareholder, and whether the product is sold through a large bank. In addition, the spread-to-risk sensitivity is flattened by strong guarantees.

Keywords: Shadow banking, trust products, implicit guarantee, yield, real estate

JEL Classification: G2, G3, L2

Suggested Citation

Allen, Franklin and Gu, Xian and Li, C. Wei and Qian, Jun and Qian, Yiming, Implicit Guarantees and the Rise of Shadow Banking: The Case of Trust Products (September 15, 2021). Available at SSRN: https://ssrn.com/abstract=3924888 or http://dx.doi.org/10.2139/ssrn.3924888

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Xian Gu

Durham University Business School ( email )

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

C. Wei Li

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business
Iowa City, IA 52242-1097
United States
319-335-0911 (Phone)
3193353690 (Fax)

Jun Qian

Fanhai International School of Finance, Fudan University ( email )

Shanghai
China
86-21-63895501 (Phone)
86-21-62934572 (Fax)

HOME PAGE: http://www.fisf.fudan.edu.cn/show-65-69.html

Yiming Qian

University of Connecticut ( email )

2100 Hillside Road U-1041F, Room 452
Storrs, CT 06269
United States
860-486-2774 (Phone)

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