This study investigates the effectiveness of China’s Medium-term Lending Facility (MLF) in influencing shadow banking activities among non-financial corporations. Analyzing data from Chinese A-share listed firms between 2009 and 2017, we find that firms with higher MLF exposure engage more in shadow banking, supported by robustness checks. The MLF affects shadow banking primarily by expanding corporate collateral capacity and facilitating interest rate arbitrage, while traditional bank liquidity transmission is not a direct factor. The impact is particularly significant for firms with greater reliance on external financing, stronger political ties, closer banking relationships, and larger scales. Notably, despite stimulating shadow banking growth, these activities do not lead to measurable improvements in corporate value or innovation. Our findings enhance the understanding of monetary policy transmission in China, highlighting the unintended consequences of collateral-based tools and their implications for achieving financial stability alongside economic growth.