Shadow banking, does it manage China or does China manage it?
Creators: name: Yuen, Isabelle
Publisher: name: Figshare
Year: 2017
Subjects: subject: Law
subject: FOS: Law
subject: 150299 Banking, Finance and Investment not elsewhere classified
subject: FOS: Economics and business

description: 1. The significance of understanding the dissertation
topic is that China has become the second largest economy. Since China has
reformed for three decades, and now is a key driver to the global economy.
Given this fact, China can produce spillovers to other countries’ economy
through channels such as trading, supply chain, foreign exchange reserve and
offshore renminbi markets. In China, the stimulus package in 2008 fuelled the
growth of shadow banking, which has played an important role to meet the demand
from depositors looking for higher return and from borrowers who invest in real
economy. 

 

2. Characteristics in shadow banking were present in
history that dates back to the 18<sup>th</sup> century. Shadow banking
activities proliferated during 1970 by a dominant form of structured finance
–securitization. It is not until August 2007 that the term ‘shadow banking’ was
introduced. After studying various definitions, shadow banking has the
characteristics of credit intermediation involving savers and borrowers, thus
it is subject to maturity mismatch; it is outside regular banking and has no
liquidity support nor under any deposit insurance from government; it has
little or no capital reserve requirement and is able to create money. Due to
these characteristics, shadow banking can inflict a systemic risk on a
financial system as a whole. It is interconnected by its relative size and
multiple linkages. Thus the systemic risk that shadow banking causes to
financial systemic can be concluded as susceptibility to ‘run’ the shadow banks
and amplifying negative effect of high leverage.

 

3. The Chinese financial industry is monopolised by
banks; financing activities are mainly conducted through the banking system. The government has high level of ownership
and control over the five largest banks which are motivated to lend to
state-owned enterprises. The private entities would gain the needed credit from
shadow banks directly or via the financial products. 

 

Modified from definition of the FSB, China’s shadow
banking should be defined as a system of chain intermediation activities and
entities outside regular banking system or within it but falling outside scope
of regulation. The dissertation discussion would be limited to better developed
institutions and investment products. 

 

It is analysed that the most risky area of shadow
banking is its wealth management products originated from the financial
institutions that could build up leverage in the form of off-balance sheet
transaction. Secondly, systemic risk that Internet financial institution bears
could be significant. Internet create is closely interconnected with the
regular banking through the channel money market fund. It also would accept
deposit that is not guaranteed and the fund is prone to misappropriation.

 

4. During periods
of economic stability, the government introduced a number of regulations on
shadow banking. The Document 107 released by China in late 2013 is the first
regulation which sets out a framework and general principles to monitor and
regulate it. It is binding on all regulators who are required to coordinate
with each other. This will help build up macro prudential measures to regulate
shadow banking.

 

Secondly, the
wealth management business in banks and trust companies arguably creates the
most significant systemic risk due to its wealth management products being
intertwined with regulated banks. A number of regulations have been
released in response to industry development and changes in economy, however
comprehensive legislations are still missing. 

 

The shadow banking activities in China are not
entirely unregulated. Any individual undertaking fundraising from the general
public without proper authorisation from the government can be prosecuted for
illegal fundraising under Criminal Law. The severity of the punishment should
deter the activities of underground banking and unauthorised deposit taking. 

 

5.
The Chinese government will only intervene more proactively when shadow banking
poses a rising risk to the economy, as the government viewed it as a necessity.
Removing the ceiling on deposit rates is arguably an effective means of curbing
shadow banking. To ease the pressure of liberalising deposit rates, one way
would be through Internet finance which could help develop the financial
industry and bring in more competition. If the government wants to control the
growth of Internet finance, they could introduce varying degrees of
regulations. One way is the law prohibiting illegal fundraising. However, it is
clear that the Chinese government is reluctant to regulate Internet finance and
therefore it is likely to remain unregulated for the foreseeable future.

 

6.
In addition to regulating shadow banking during periods of economic stability
and when risk is building up, it is important to assess the tools the Chinese
government could employ when a financial crisis is imminent. The tools should
be able to address systemic risks by shadow banking to the financial system. It
is concluded that ‘guaranteed payout’ would prevent a ‘run’ in
financial industry. Additionally, the government’s control on banks allows
early intervention which is likely to be an effective tool in counteracting the
amplifying negative effect of high leverage.

 

7. Since China is not an open economy like developed
countries, it can exercise influence on the financial industry. Therefore they
can employ their regulatory tools more flexibly. In light of the above, it is
submitted that China should be able to manage the risks posed by shadow banking
to financial sector