Demand and Supply of Shadow Banking in China

Abstract

Shadow banking is a major financial risk faced by Chinese policy-makers today. Instead of assessing, as others do, its size and impact, this chapter examines the demand and supply side of China’s shadow-banking system. This distinction increases, on the one hand, the understanding of the drivers of the rapid growth of shadow banking in recent years. On the other hand, the distinction allows to derive targeted policy measures to contain the size and risks of shadow-banking activities in the future. The chapter looks into the definition of shadow banking (Sect. 2), puts Chinese shadow banking into perspective by assessing its structure, causes and risks (Sect. 3), and analyses, in greater detail, its demand and supply sides (Sects. 4 and 5 respectively). It finds a high degree of inter-connectedness of China’s biggest challenges (shadow banking, public and corporate debt, financial repression and real estate issues), something which has to be taken into account when designing policy measures. The chapter concludes (Sect. 6) that, on the demand side, further fiscal reforms are needed to sort out the relationship between central and local government, so that local governments can secure the funding needed for urbanisation. On the supply side, interest rates should be further liberalised to avoid “bad money” driving out “good money”.