Government Policy’s Influence on Shadow Banking in China

Shadow Banking in China

Shadow banking in China plays an important role in China’s overall financial system, but assessments of its impact vary widely. In this paper, Sarah Hsu describes how shadow banking is viewed by Chinese government officials and industry experts as overly risky and potentially undermining the formal financial system. But shadow banks are filling a gap in the provision of finance to particular sectors and smaller firms. Hsu analyzes the impact of government regulation on the shadow banking and non-shadow banking financial sector (i.e., the stock market) and proposes ways to strengthen the regulations of shadow banks to improve access to credit.

Abstract

Shadow banking in China has been viewed by government officials and industry experts as illegitimate finance, but as a key means of financing by others. For the former, the industry has been seen as overly risky, potentially undermining the formal financial system. The latter see shadow banking as an increasingly important part of the financial system, filling a gap in the provision of finance to particular sectors and smaller firms.

In this paper, we seek to understand the effect of government views on shadow banking by analyzing the impact of government regulation on the shadow banking and non-shadow banking financial sector (i.e., the stock market). Using a unique data set based on data collected from various sources, we find that shadow banking regulation plays a strong role in China’s financial sector. We also discuss ways in which China’s shadow banking sector has not gone far enough in deepening Chinese finance, and make suggestions as to how regulators could lead the way in improving direct and market-based finance.

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