Shadow banking in China

The rise of shadow banking in China

In this paper, Acharya et al. show that large-scale fiscal policies, and not just monetary policy, can also give rise to the rapid growth of the shadow banking system. They focus on the role the 2009-2010 RMB 4 trillion fiscal stimulus played in the growth of shadow banking in China. In particular, they look at the rapid rise of Wealth Management Products (WMPs), one of the largest components of China’s shadow banking sector, issued by banks and which can be regarded as short-maturity, off-balance-sheet substitutes for deposits. The authors explain the mechanism behind the rise in WMPs:

• The GFC led to a slowdown in deposit growth for Chinese banks from reduced cross-border money inflows, especially for the Bank of China (BOC) which was heavily exposed to the import-export sectors.
• The Chinese government’s fiscal stimulus was funded through massive credit expansion by banks, with BOC being particularly aggressive.
• This combination of slowing deposit growth and aggressive lending caused BOC’s loan-to-deposit ratio to spike, intensifying its need to compete for deposits after 2010 when monetary policy tightened.
• Using branch overlap of smaller banks with BOC as a measure of exposure to BOC’s intensified deposit competition after 2010, the authors find that more exposed banks issued more WMPs to substitute for the loss of deposits.
• The shift from deposits to WMP financing exposed banks to greater rollover risks, as reflected in higher yields offered on new WMPs when more WMPs were maturing, higher interbank borrowing rates, and worse stock performance during periods of liquidity stress.

The key findings suggest that fiscal stimulus, even without monetary easing, can spur the growth of shadow banking and financial fragility by intensifying deposit competition among banks and driving them to issue more unstable short-term liabilities like WMPs.

Fiscal Stimulus, Deposit Competition, and the Rise of Shadow Banking: Evidence from China
Authors: Viral V. Acharya, Qian Jun, Yang Su, Zhishu Yang
From: New York University, Fudan University, Chinese University of Hong Kong, Tsinghua University

The current state of China’s shadow banking

Zhang and Tsai in this paper describe the current state of shadow banking in China and explain why it has persisted despite repeated policy efforts to contain it. Their findings include:

• China’s contemporary shadow banking system has bifurcated into two segments since the late 2000s:
  a) The conventional “entrepreneurial shadow” that provides informal credit to private small and medium enterprises.
  b) The “fiscal shadow” that caters to property developers and local government financing vehicles (LGFVs), which are the two pillars of China’s land-based local public finance regime.
• The central government’s Global Financial Crisis stimulus plan in 2008-09 fueled a debt-financed real estate and infrastructure construction boom, launching property developers and LGFVs onto a highly-leveraged expansion trajectory.
• When the central government abruptly restricted formal credit availability after the stimulus, property developers and LGFVs became entangled in the fiscal shadow for refinancing needs, leading to the growth and persistence of this segment of shadow banking.
• Despite policy efforts like introducing local government bonds and deleveraging campaigns since 2014-2017, the reliance of local public finance on shadow banking has only been moderated but not effectively reversed.

The authors attribute the growth and persistence of China’s shadow banking system in large part to the unmet financing needs of local public finance, underscoring the mutual dependence between shadow banking and local debt as two major sources of systemic financial risks.

“One System, Two Shadows”: A Local Public Finance Perspective on China’s Shadow Banking System
Authors: Shidai Zhang, Kellee S. Tsai
From: Hong Kong University of Science and Technology, Johns Hopkins University