This paper uses a loan transactions dataset from China to identify whether shadow loans cost more than formal bank loans even with collateral. This motivates us to explore the reasons as to why a listed firm would opt for such loans. Using propensity-score matched data, we find that privately-owned firms with shadow loans are forced to obtain these loans since they are politically discriminated following a regulation change in 2009 that favoured state-owned firms. However, state-owned firms obtain shadow loans due to their inferior firm characteristics. Further, we employ a Difference-in-Differences methodology to uncover that privately-owned firms experience a decline in their performance, investment growth and an increase in default probability following their high dependence on shadow loans when they are excluded from the formal loan market. The above results survive various robustness checks, including doubly-robust inverse-probability weighted Difference-in-Differences regressions.