We provide firm-level evidence on the real effects of shadow banking in terms of technological innovation. Firm-to-firm entrusted loans, the largest part of the shadow banking sector in China, enhance the borrowers’ innovation output. The effects are more prominent when the borrowers are subject to severer financial constraints, information asymmetry, and takeover exposures. A plausible underlying channel is capital reallocations from less productive but easy-financed lender firms to more innovative but financially less-privileged borrower firms. Our paper suggests that shadow banking helps correct bank credit misallocations and thus serves as a second-best market design in financing the real economy.

This paper researches into development of China’s shadow banking during 2020-2022, a special period marked by COVID-19 and strengthened global regulation on Non-Bank Financial Intermediation (NBFI). Research focus includes balance sheet evolvement, growth dynamics, and relation with macro-finance. Its business model surprisingly resembles western peers. They both fund underserved sectors and have similar exposure to balance sheet mismatch. Massive holding of bond investment (36.6% of total asset) is funded by uninsured interbank fund and wealth management product, which makes it more closely related with banks’ balance sheet and risk contagion from NBFI to traditional commercial banks more easily. This paper then re-summarizes growth dynamics of China’s shadow banking in a “Pull-Push” framework, and proposes concept of reintermediation in respective to disintermediation. Consecutive regulation on NBFI and real estate sector kept dragging on growth of shadow banking, and rendered it in liquidity surplus, which is invested into interbank market. This paper also provides empirical evidence on relation of China’s shadow banking with macro-finance, and notes several empirical breakdowns of pre- COVID relations among economic and financial indicators. Most important breakdown is the non-functionality of monetary policy transmission channel. Besides, it continued to twist de facto financial regulatory indicators, however with fading impact.

This paper argues that ffnancial lease, a dominant representation of shadow banking in China, plays a special role in improving the capital allocation efficiency. In a two-sector general equilibrium model with heterogeneous firm, information asymmetry and financial frictions, this paper shows that existence of finance lease market increases aggregate TFP by allowing low productivity SOE firms to lend out and allowing high productivity POE firms to leverage up. Due to the repossession advantage, financial leasing is a “good“ form of shadow banking that does not necessarily cause financial systemic risks.

We develop a banking model to explain the remarkable growth of China’s shadow banking since the global financial crisis. In the presence of local government interventions for low-quality projects due to short-termism, a policy combination of tightening formal banking and loosening shadow banking can reduce inefficiency given the information asymmetry between banks and regulators. This is because the higher funding liquidity risk of shadow banking incentivizes banks to be more disciplined about the quality of projects. We find consistent empirical evidence that when on-balance-sheet financing was constrained by regulators, banks shifted high-quality projects into shadow banking and rejected low-quality ones.

We show that government deleveraging causes corporate distress in a distorted financial market. Our difference-in-differences analysis exploits China’s top-down deleveraging policy in 2017, which reduces local governments’ borrowing capacity through shadow bank financing. Private firms with government procurement contracts experience larger accounts receivable increases, larger cash holdings reductions, and higher external financing costs. These firms also experienced greater likelihoods of ownership changes and deteriorated performance. Effects are muted for state-owned enterprises, which enjoy funding privileges in China’s financial system. Our paper thus reveals a novel channel of allocation inefficiencies where government deleveraging amplifies adverse impacts of financial distortions.

Deregulation may increase bank stability. Employing China’s loan-to-deposit ratio (LDR) reform in 2015, we show that the deregulation of the LDR increases the stability of banks. Specifically, the deregulation of the LDR alleviates banks’ deposit competition, and decreases reliance on customer deposit funding. By doing so, it improves the loan structure among banks with a high LDR, which, in turn, increases the on-balance-sheet stability of these banks. Meanwhile, the deregulation of the LDR curbs high-LDR banks’ impulse to issue principal-floating wealth management products, a form of shadow banking, which thus increases their off-balance-sheet stability.

We study how shadow banking affects the effectiveness of monetary policy in China.Using novel data on bank-issued off-balance sheet wealth management products (WMPs), we show that banks improve their on-balance sheet risk profile by issuing WMPs. This in turn lowers the sensitivity of banks' wholesale funding cost to monetary policy and reduces the effectiveness of the bank lending channel. The effect of our mechanism on total credit is quantitatively similar to the effect arising from the substitution between traditional loans and shadow banking loans previously analyzed in the literature. The channel documented in this paper has novel implications for the regulation of banks' off-balance sheet activities and market-based funding.

We provide firm-level evidence on the real effects of shadow banking in terms of technological innovation. Firm-to-firm entrusted loans, the largest part of the shadow banking sector in China, enhance the borrowers’ innovation output. The effects are more prominent when the borrowers are subject to severer financial constraints, information asymmetry, and takeover exposures. A plausible underlying channel is capital reallocations from less productive but easy-financed lender firms to more innovative but financially less-privileged borrower firms. Our paper suggests shadow banking helps correct bank credit misallocations and thus serves as a second-best market design in financing the real economy

China’s shadow banking system has experienced surprisingly high growth since the global financial crisis. We develop a model to understand this puzzling phenomenon. With local government interventions in bank loans for low-quality projects and information asymmetry between banks and regulators, a policy combination of tightening formal banking and loosening shadow banking can reduce inefficiency, because the higher funding liquidity risk of shadow banking incentivizes banks to be more disciplined about the quality of projects. We find consistent empirical evidence that when on-balance-sheet financing was constrained by regulators, banks primarily shifted high-quality projects into their controlled shadow banking system.

Although implicit guarantees are widely used in the shadow banking system, we know very little about its qualitative and quantitative properties. In this paper, we use a micro-level data set on China's shadow bank products to quantify the risk of implicit guarantees. We find a robust empirical fact that banks extend more implicit guarantees to their shadow bank debt (i.e., wealth management products) when their own default risks increase. Our result shows that this effect is particularly stronger when riskier banks plan to issue certificates of deposits in the interbank market. A simple model that is based on a signaling game is proposed to rationalize this fact. The key mechanism of the model is that as a bank's reputation becomes worse, it has stronger incentives to send positive signals to the market, i.e., to boost the realized returns of its shadow bank obligations, although it has no obligation to do so. Our findings show that implicit guarantees have nonlinear negative effects on bank fundamentals and the risk-weight of off-balance-sheet exposure should be increasing in banks' default risks.