Skip to main content

Shadow Banking in China (Chen, Ren and Zha 2018 AER)

Shadow Banking in China receives rising attention from both the press and the academia. In  The Nexus of Monetary Policy and Shadow Banking in China  (2018 AER, NBER WP23377,  NBER WP21890), Chen, Ren and Zha discuss the interplay between China's quantity-based monetary policy and commercial banks' reaction in terms of shadow banking activity. In this blog, I highlight their theory and  findings on shadow banking in China.

One feature in China's banking system is an institutional division of state and nonstate commercial banks. State banks are state owned and the remaining commercial banks, as a whole represent almost half the size of the entire banking system, are nonstate banks. State banks adhere to the government's own policy against actively bringing shadow banking products into their balance sheet. This is not true of nonstate banks, however. As found in the paper, nonstate banks take advantage of regulatory arbitrage by bringing shadow banking products into a special investment category on the asset side of their balance sheet, account-receivable investment (ARI), which is not subject to the regulations on shadow banking.

The paper proposes a tractable theory of banks' optimal portfolio problem to explain the incentive to expanding shadow banking business when they face contractionary monetary policy. When monetary policy tightens unexpectedly, the cost of attracting deposits increases and banks need to invest into assets with higher return (more risky assets) to offset the cost. If banks can exploit regulation arbitrage, they could promote shadow banking  by bringing off-balance-sheet products onto the balance sheet in a category shield from government regulation and by participating in more off-balance-sheet shadow banking activity.

They test the theory by providing two sets of empirical evidence: one on the entrusted loans facilitated by banks/other financial institutions to  represent off-balance-sheet shadow banking activity; one on ARI excluding central bank bills to represent on-balance-sheet shadow banking activity. The find a significant increase in both off-balance-sheet and on-balance-sheet shadow banking activity by non state banks, while no such evidence for state banks.

This implies a serious problem for the effectiveness of monetary policy. When the monetary policy tightens, the bank loans do decrease, but the amount of shadow banking activity increases. The total credit, the sum of bank loans and shadow banking assets, could rise instead of falling. This means the contractionary money policy is ineffective if there is no regulatory restriction on banks' participation in shadow banking activity.

Reference
Chen, Kaiji , Ren, Jue and Zha Tao, The Nexus of Monetary Policy and Shadow Banking in China, AMERICAN ECONOMIC REVIEW (FORTHCOMING)

Comments

Post a Comment

Popular posts from this blog

China’s Gradualistic Economic Approach and Financial Markets (Brunnermeier, Sockin, Xiong, AER P&P, 2017)

"A key approach successfully employed by China to reform its economy in the past 30 years is the so-called "crossing the river by touching the stones" approach, a gradualistic method that optimizes policy through experimentation. The government will start with an initial (usually small) policy change, and gradually modify the policy based on the reaction from the economy to this change."  BUT, "Can China continue to use its gradualistic approach in the presence of active financial markets?" In  Brunnermeier, Sockin, Xiong, (AER P&P, 2017) , they provide the theoretical rationale for potential ineffectiveness of gradualistic policy approach with the existence of an active financial market. In align with the well-known time-inconsistency problem (Kydland and Prescott (1977) and Barro and Gordon (1983) ), incentives of front-run by private agents in expectation of ex post non commitment of the policymaker renders the gradualistic approach ineffective. ...
Post a Comment
Read more

Cultural and Institutional Bifurcation China and Europe Compared, by Avner Greif and Guido Tabellini, American Economic Review, 2010

How to explain the cultural and institutional bifurcations between China and Europe? In their paper Cultural and Institutional Bifurcation China and Europe Compared , Avner Greif and Guido Tabellini ( AER  2010 citation:187) demonstrated that initial distribution of values and social heterogeneity themselves alone could be the reason. Two otherwise identical societies can evolve along different self-reinforcing trajectories of both cultural traits and organizational forms. The collapse of the Chinese Han dynasty and the Roman Empire (after 220 CE) were turning points in the cultural and institutional evolution of China and Europe respectively. Large kinship organizations were common in the former but not the latter and this remarks the distinction in initial conditions. In China, the Han dynasty came to power while advocating Confucianism as an alternative to the Legalism of the previous Qin dynasty. Confucianism considers moral obligations among kin as the basis for social or...
Post a Comment
Read more

Capital Accumulation, Private Property, and Rising Inequality in China, 1978–2015, By Piketty, Thomas, Li Yang, and Gabriel Zucman

China has seen a large economic expansion after 1978. What is the distribution of the wealth accumulated through the economic expansion? Piketty, Yang, and Zucman ( 2019, AER ) provide the first piece of evidence on the wealth distribution between the public and private sectors, and top and bottom individuals. They find that the ratio of national wealth to national income has increased from 350 percent in 1978 to 700 percent in 2015.  The share of public property in national wealth has declined from 70 percent in 1978 to 30 percent in 2015. More than 95 percent of the housing is now owned by private households, as compared to 50 percent in 1978. 30 percent of equities of the listed companies are owned by private Chinese entities, 60 percent to the government, and  10 percent to foreigners. "China has ceased to be communist, but is not entirely capitalists; it should rather be viewed as a mixed economy with strong public ownership. The share of public property in China ...
Post a Comment
Read more