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

Dividends and expropriation, Faccio, Lang, and Young (2001 AER)

 The failures in East Asian corporate governance are blamed for the East Asian financial crisis.  In East Asia, the predominant form of ownership is control by a family, termed as "crony capitalism", and the top managers are often from the family. In  Faccio, Lang, and Young (2001 AER, citation 1861) , they document ownership and control structures among East Asian corporations and analyze the salient agency problem, namely the expropriation of outside shareholders by controlling shareholders, by looking at dividend behavior. To start with, they show an extraordinary concentration of control in East Asia, whereby 6 groups control more than 20% of the corporations in the 9 most advanced East Asian economies. This control is obscured behind layers of corporations, hence insulated against the forces of competition on less-then-transparent capital markets. However, family control is also predominant in West Europe, though the group sizes are smaller, with 5 groups control about
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 order,
Post a Comment
Read more

TFP Differences and Capital Misallocation in Developing Countries: Hsieh and Klenow (2009) and Virgiliu and Xu (2014)

Cross-country income differences for the most part reflect differences in total factor productivity (TFP) across countries. But what could explain the differences in TFP in different countries? Hsieh and Klenow (2009, QJE, citation 3021) , use establishment level data in manufacturing to measure TFP gaps between China and India and the U.S. They find that misallocation in labor and capital could explain 30%-60% of the TFP differences between developing and developed countries, which means that  China and India have low TFP mainly because that resources are not allocated in the most efficient way. Virgiliu and Xu (2014, AER, citation 571) extend the framework to study the role of financial frictions in determining TFP. They focus on one specific type of misallocation, distortion in capital allocation generated by financial frictions. However, they find that this type of misallocation explains only a small part, 5%- 10%, of the TFP differences. However, financial frictions reduces n
Post a Comment
Read more