BOFIT Viikkokatsaus / BOFIT Weekly 2019/37

Shadow banking in China got its start after the partial deregulation of financial markets and restrictions on bank lending. Recently, however, the size of the shadow banking sector has shrunk.

In its latest Article IV report (see above), the IMF notes that regulatory measures to curb shadow banking have largely succeeded, with sector assets shrinking to just over 20 trillion yuan (2.8 trillion dollars). The IMF, however, wants further measures to force informal financing into the formal banking sector. Unlike in the US and Europe, in China the shadow banking sector is focused on lending to firms rather than households for e.g. housing.

Chinese shadow banking features several different contractual and lending arrangements. All involve marshalling investor assets for lending while avoiding the need for a bank to stand formally as creditor, serving instead as a mere intermediary (a role non-banks can also perform). While there is no precise definition of shadow banking, certain modes of financing deserve mention.

Wealth management products are based on agreements, whereby the investor agrees to place assets in an uninsured account and allow the bank to lend or invest those assets on behalf of the client in the hope of a high return. The assets are not included on the bank’s balance sheet and the bank is not otherwise obligated to the investor. Typically, the money is not invested in securities, but loaned to debtors under a standard lending contract. Such investments are often thought to have the bank’s implicit guarantee, so they are considered safe investments. Officials are currently promulgating new rules banning such implicit guarantees. These rules should be fully in force by the end of 2020.

Entrusted loans also rely on an agent bank relationship. The bank negotiates and intermediates the loan between two parties, handing the loan documents, but not assuming liability for failed performance of the loan parties. The parties are typically firms, but the bank has occasionally later purchased the debt note for itself. The firm placing the assets to be lent has some say at to whom their money is lent.

Trust loans are arranged by various trust companies, which also take in investments from banks. Such loans are granted to debtors with lower creditworthiness that may disqualify them from eligibility for a regular bank loan.

Peer-to-peer lending (P2P) typically is done online. It allows private individuals to lend to each other via a platform provided by a third party. With the collapse of several platforms, officials have sought to restrict growth of P2P lending.