Shadow Banking: China's Dual-Track Interest Rate Liberalization

Abstract

Shadow banking in China is mainly conducted by banks to evade the excessive credit control, which constitutes a dual-track approach to liberalize the country's rigid interest rate policy. The market track of shadow banking can lead to efficiency gain by allowing credit resale to fund the more productive yet credit-deprived private enterprises (PEs). Pareto improvement can be achieved as the banks and state owned enterprises (SOEs) participate in shadow banking and share the efficiency gain. Full interest rate liberalization may not lead to additional efficiency gain, as it magnifies the credit mis-allocation in favor of the less productive SOEs.