RESEARCH PAPER IN ECO CLASS.

Running head: CHINA’S SHADOW BANKING SYSTEM �1

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China’s Shadow Banking Systems

Hind Z. Aljohani

Marymount University

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Introduction:

Shadow banking systems act as financial intermediaries between large borrowers and

lenders. Even though shadow banking systems are involved in the creation of credit, they are

subjected to lesser governmental regulatory oversight compared to commercial banks (Dang et

al., 2015). Entities that constitute shadow banking systems include hedge funds, mutual funds,

and structured investment vehicle. Entities that comprise the shadow banking systems earn their

revenues through fees they charge and interest rate spreads. Shadow banking systems in China

are a unique case in that they are comprised mostly of state-controlled commercial banks.

Shadow banking has had a positive effect on China’s economic growth, and according to

Moody’s Investor Service, accounted for nearly 65% of China’s Gross Domestic Product in

2014.

On a global level, shadow banking accounts for almost a quarter of the money transferred

between lenders and borrowers. In an emerging market such as China, shadow banking provides

retail investors a place to store their funds and loans to borrowers smaller than what the official

state policy permits. The Chinese shadow banking system has its origin in regulatory arbitrage

constituted by interest rate control measures and limits on market-based finance of a quantitative

nature. Shadow banking in China circumvents rules imposed on loan-to-deposit as a form of off-

balance sheet bank lending system.

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Statistics behind China’s Shadow Banking System:

• According to the Financial Stability Board, China’s shadow banking was estimated to be

worth over 3 trillion dollars by the end of 2014.

• The shadow banking system in China was up from 42% in 2012 to 51% in 2014 of

China's gross domestic product. In 2014 it was approximately worth over 5 trillion dollars

(Bottelier, 2015).

United States of America and China’s Shadow Banking Systems:

China’s shadow banking system has enabled their economy to grow at a very fast rate of

approximately 10% per annum and has reached that of first world nations, for example, the

United States of America (Dang et al., 2015). Securitization structures in Unites States’ financial

sector and trust loans in China both face strict regulatory policies. In China, the shadow banking

systems rely on the country’s banks to facilitate their functions, while in the United States it

depends on redistribution of risk, credit intermediation and pricing systems. The main difference

though occurs in the two systems interpretation of assets that the respective financial systems

consider safe. China’s shadow banking system is relatively simpler compared to the United

States’.

 Drivers of China’s Shadow Banking Systems:

Investors in China are continuously discouraged by the low-interest rates offered by

banks and therefore sort for an alternative in shadow banking. The interest rates provided by

Chinese commercial banks do not match the country’s inflation rate, and therefore real estate,

and equity markets, became weaker investments (Luo, 2016). Commercial banks in China at the

Running head: CHINA’S SHADOW BANKING SYSTEM �4

same time were being discouraged from lending money to smaller entities. Liquidity restraints

placed on commercial banks by the Chinese government also restricted banks to give more than

75% of their net deposits. Chinese banks were left with no other choice but to develop vehicles,

which would allow them to lend money to whatever entities irrespective of their size, through the

use of new product packages.

Wealth management products became an intricate part of the shadow banking system.

Wealth management products allow investors to pay up short-term money against larger loans,

and at times more than one loan. In China, wealth management products have several categories,

and some structures in them are different from the bank-created sector, in that they often lend

money to lower profit sectors of China’s economy. Examples of such sectors in China’s economy

with reduced volatility include mining and real-estate sectors. In essence, wealth management

products are just another way of labeling bank deposits, without all the regulations that

accompany them. Wealth management products in China are worth over 15 trillion dollars and

represent over 25% of China’s gross domestic product (Sheng & Ng, 2016).

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Reference

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