Shadow Banking System Research Articles

Shadow banking, macroprudential regulation and redistributional effects*

ABSTRACT This paper studies the implications of increasing the size of the shadow banking sector for economic activity, financial stability, and welfare. I consider a DSGE model in which lending can come from two different sources; a formal bank or private lending. Banking regulation, in the form of capital requirements, only applies to the formal banking sector. Private lenders represent the shadow banking system. Results show that an increase in shadow banking leads to a higher amount of credit in the economy, which in turn implies higher consumption by borrowers. However, after a certain threshold, a large proportion of shadow banking is welfare decreasing. Moreover, the presence of an unregulated banking sector can lead to unintended effects of macroprudential policy. That is, stricter regulation in the traditional banking sector by the authorities may result in an increase in credit flows to those banks with lower regulatory levels, especially when this regulation comes from borrower-based instruments. Thus, macroprudential authorities should take into account these redistributional effects of shadow banking when considering their regulatory perimeter.

The Banking Act Study on Shadow Banking System

The Banking Act Study on Shadow Banking System

The Research on Shadow Banking System in China and Its Impact on Small and Medium Enterprises (SMEs) Financing --- Taking Wealth Management Products as an Example

The project aims to explore the shadow banking system in China and its impact on small and Medium Enterprisess (SMEs) Financing. It mainly studies the development of shadow banking in the last ten years, the effects of regulation in the financial industry, and its shape process of the financial injection into small and Medium Enterprisess, the source of funds, and the balance of the shadow banking system in four main channels, and the structure of wealth management products. This paper concluded that the development of the shadow banking system, especially the industry of wealth management products, has encouraged the SMEs financial to some extent. However, more regulation policies focused on the hidden risks are still needed to develop.

The Comparison of Shadow Banking System Between in US & China: Definition, the Formation Way, Reason for Lack of Regulation, the Development, and Shadow Banking System

The Comparison of Shadow Banking System Between in US & China: Definition, the Formation Way, Reason for Lack of Regulation, the Development, and Shadow Banking System

The contraction of Chinese shadow banking and corporate investment behavior: Evidence from the background of the “New Rules on asset management”

Employing the exogenous scenario of the “New Rules on Asset Management” in April 2018, this paper tries to explore the impact of the contraction of Chinese shadow banking on corporate investment behavior. This paper finds that the regulation leads to a 18.3% decrease in capital expenditure for firms relying on shadow banking system prior to the shock. Then, this paper tests three underlying mechanisms, which include the decrease of corporate borrowing, the increase of corporate financing constraints and the reduction of debt maturity. This paper also provides the empirical evidence that the implementation of the “New Rules on Asset Management” optimizes the allocation of capital across firms.

‘One System, Two Shadows’: A local public finance perspective on China's shadow banking system

Why does shadow banking persist in China despite repeated policy efforts to contain it? While studies of informal finance have traditionally emphasized the credit needs of private businesses as a demand-side explanation, this study contends that China's local public finance also constitutes an important driver for shadow banking. Based on document research and administrative data, we find that China's shadow banking system has bifurcated into two segments since the Global Financial Crisis (GFC). One is the ‘entrepreneurial shadow’ that has long provided informal credit to the private sector, especially small- and medium-sized enterprises. The other is a ‘fiscal shadow’, which serves property developers and local government financing vehicles (LGFVs), the two pillars of China's land-based local public finance regime. Property developers are major contributors to local fiscal revenues through the land economy, while LGFVs function as off-balance sheet backdoor financing intermediaries for local governments.Although localities have borrowed from unconventional sources throughout the reform era, the central government's GFC stimulus plan marked a turning point by fueling a debt-financed real estate and infrastructure construction boom. Property developers and LGFVs were launched onto a highly leveraged model of feverish expansion for over a decade. When the central government abruptly reversed its course by restricting the availability of formal credit, they became further entangled into the fiscal shadow for refinancing. Local public finance has thus become reliant on shadow banking, despite subsequent policy efforts to curb such activity. Our findings suggest the need for a more integrated analytic and regulatory framework that recognizes the mutual dependence between shadow banking and local debt – two major sources of systemic financial risks in China.

The Research on the Impact of Shadow Banking on Small and Medium-sized Enterprises in China

Because of the serious financial repression in China's financial system, the traditional commercial bank's credit is very large. It is difficult to reach small and medium-sized enterprises and industries restricted by credit policies. In order to solve this existing problem, those Independent of traditional commercial banks, not subject to or less supervision by the central bank, and capable of providing credit Institutions have emerged, traditionally known as shadow banks. Shadow banks have been quantitative easing money It played an important role in the implementation of the policy. This paper will explain China's shadow banking system from the introduction of shadow banking, the development of shadow banking in China and some of its impacts, as well as the introduction and analysis of special cases of shadow banking and the impact of shadow banking on small and medium-sized enterprises. This paper draws the following conclusions through research: With the growing development of shadow banking in China, China's shadow banking system is becoming increasingly complex, and small and medium-sized enterprises have gained more development opportunities due to the characteristics of high risk and high returns brought by shadow banking.

Shadow Banking in the United States: Emerging Factors, Operation Modes and the Current Situation of Supervision - Based on the Comparison with Chinese Shadow Banking System and Market

In 2009, Ben Bernanke, chairman of the Federal Reserve, described shadow banking as a financial intermediary that converts savings into investments in addition to regulated deposit-taking institutions. To put it simply, the essence of shadow banking is a financial innovation that breaks through traditional financial institutions in order to maximize profits in the financial market environment. In this paper, we compare the U.S. and Chinese shadow banking system and their market system. From that, we analyze their similarities and differences from the aspects of emerging factors, classification and scale, and operation mode. Based on the above analysis, we then discuss the current situation of supervision of shadow banking in the United States and find that the U.S. shadow banking is negligent in institutional constraints and has practical difficulties in legal supervision. Finally, we put forward some suggestions on the future development and financial structure optimization of shadow banking.

The contradictions of unconventional monetary policy as a post-2008 thwarting mechanism: financial dominance, shadow banking, and inequality

The global financial crisis (GFC) of 2008 has triggered profound changes in the macro-financial regulatory architecture. Ever since, the interplay between political, institutional, and macroeconomic developments has received increasing attention in political economy, as in the evolutionary macro-financial approach of institutional super-cycles with its concept of thwarting mechanisms. While these institutional structures aim to stabilise the macro-financial system, they may also contradict each other due to unintended side effects. This paper argues that the understanding of thwarting mechanisms can be enriched by further integrating it with political economy literature on finance within the post-GFC institutional setup. It conceptualises unconventional monetary policy as a novel thwarting mechanism and analyses the contradictory implications for overall macro-financial stability with a particular focus on aggregate demand. It suggests three reasons why this thwarting mechanism failed to restore sustained economic growth in the post-crisis decade: First, sustained large-scale asset purchases perpetuate the structural drivers of financial dominance in political power relations, entrenching the role of the shadow banking system within the macro-financial order and impairing the development of other thwarting mechanisms. Second, unconventional monetary policy maintains the tenets of the inflation targeting regime and thereby sustains neoliberal macroeconomic governance with restrained fiscal policy. Third, it exacerbates preexisting wealth and income inequality by redistributing wealth towards asset owners, undermines consumer demand, and thus contributes to stagnation tendencies. Thus, this paper suggests that the contradictions of this novel post-GFC thwarting mechanism contribute to weaken economic growth and thus fail to restore macro-financial stability.

Shadow banking, financial regulation, and bank risk in China

China's 2018 rules on wealth management products (WMPs) have led to determined efforts by regulators to reduce risk in the shadow banking system. Through theoretical model and empirical testing, we explore the impact of the regulation on WMPs and bank performance. Our study finds that after the regulation, banks changed the issuance structure and their profit and risk reduced. The capital did not flow back to on-balance sheet business and the return of WMPs decreased after the regulation.

Macroeconomic Effects and Regulatory Responses to Shadow Banking: A Literature Review

This review offers an exhaustive exploration of the shadow banking system, from its conceptual foundations to its operational intricacies. Originating as non-traditional banking entities, shadow banks have come to play a pivotal role in global finance, facilitating credit intermediation, liquidity provision, and risk distribution. While introducing innovation and additional liquidity, they also present challenges, notably evident during the 2007-2009 financial crisis. This paper delves into the functions and operations of shadow banks, the inherent vulnerabilities they introduce to the financial system, their impact on macroeconomic stability, and the evolving regulatory landscape. With a blend of theoretical insights and empirical analyses, the review sheds light on the complexities of shadow banking and the imperative for informed regulatory responses.

Securitization, shadow banking system and macroprudential regulation: A DSGE approach

We investigate the role of macroprudential policy in the presence of traditional banks and shadow intermediaries through the lens of a dynamic, stochastic, general equilibrium (DSGE) model. We examine how the shadow financial system affects macroeconomic activity and financial stability via the transmission channels of the securitization market. In general equilibrium, securitization leads to the emergence of moral hazard and regulatory arbitrage, which are not internalized by the financial system. The model uncovers a tradeoff. On the one hand, shadow intermediaries increase aggregate efficiency by allowing for capital redeployment through the securitization market. On the other hand, they exacerbate externalities underlying financial intermediation. We show that a macroprudential authority aiming at mitigating these externalities via limits to bank leverage and caps to securitization in the traditional banking sector, faces a welfare-volatility tradeoff. The results call for policy measures addressed to the shadow banking sector in order to ensure a more stable financial system.

Optimal Capital Structure and Risk Management Policies of Banks That Use CoCo Futures to Hedge Financial-Sector Risk

Abstract We investigate the joint optimal risk management and capital structure decisions of banks when they use contingent-convertible (CoCo) futures contracts to hedge financial-sector risk. In spite of banks choosing significantly higher leverage ratios, their default probabilities drop appreciably while their equity values increase, allowing banks to compete more favorably with the shadow-banking system. Banks’ value-maximizing decision to hedge financial-sector risk unintentionally leads to an economy with extremely low aggregate bank default rates across all future states of nature. Thus, CoCo futures offer a powerful microprudential and macroprudential policy tool. That banks choose not to hedge financial-sector risk in practice is consistent with managers internalizing bank bailouts.

Economic policy uncertainty, non-financial enterprises' shadow banking activities and stock price crash risk

At present, the structural contradiction between Economic Financialization and the real economy's long-term weakness has become increasingly prominent. As China enters a “new normal” stage of economic growth, the real investment rate drops, non-financial enterprises continuously allocate resources to the shadow banking system. The financial economy becomes increasingly divorced from reality. This leads us to the questions: will the shadow banking behavior of non-financial companies exacerbate the risk of stock price crash risk? How does the increase in economic policy uncertainty affect the relationship between non-financial companies' shadow banking activities and stock price crash risk?This article uses non-financial listed companies' data from 2007 to 2017 and conducts empirical analysis to answer this question. The study finds that companies engaged in high-leverage, high-risk shadow banking business exacerbate stock crash risk. This effect is only pronounced in non-state-owned enterprises and low social trust regions. The increase in the degree of economic policy uncertainty positively impacts the relationship between non-financial companies' shadow banking business and stock price crash risk. The theoretical mechanism is as follows: the rise in economic policy uncertainty amplifies the positive relationship between shadow banking activities of non-financial companies and stock price crashes by increasing bank loans, investors' sensitivity to external information, risk cross-contagion, and inefficient investment mechanisms. Various robustness tests do not change the research conclusion. This paper has important theoretical and policy guidance significance for reviewing the existing diversified shadow banking system and preventing systemic risks.

Analysis of the non-linear relationship between Interest Rate Distortions in China’s Shadow Banking System and short-term Capital Flows

ABSTRACT Using semiparametric generalized additive models, we studied how the market-based interest rates in China’s shadow banking system and interest rate distortion affect the country’s short-term capital flows. We used big data of shadow banking products to calculate the shadow banking interest rate and the interest rate distortion index. We improved the indirect measurement method for capital flows and used the bounds testing cointegration approach to measure China’s monthly short-term capital flows. With the calculated data, we estimated the nonlinear impact of shadow banking interest rate spreads and interest rate distortion on short-term capital flows. Results indicate that a higher shadow banking interest rate spread creates greater short-term capital inflows and the degree of interest rate distortion has a non-linear inverted U-shaped effect on short-term capital flows. Thus, the Chinese government should proceed with interest rate liberalization to eliminate the current “dual-track interest rate system” and strengthen the monitoring of cross-border capital flows so as to reduce the risks of abnormal short-term capital flows.

Collateralized Loan Obligations: A Primer

In recent years, collateralized loan obligations, or CLOs, have become the largest nonbank lender in the U.S. This added source of financing, which lies outside the purview of banking regulation, has given rise to the concept of a “shadow banking system.” And the lack of transparency and regulatory oversight of CLOs and shadow banking have led to concern that this growing market might contribute to a financial crisis similar to the GFC of 2007‐2008, which was triggered by the securitization of subprime mortgages.The authors provide a first look at CLOs and their distinctive features as a securitization vehicle that allowed them not only to weather the 2007‐2008 financial crisis but to thrive in the post‐GFC world. Though the collateral performance of CLOs suffered during GFC, their recovery was faster and stronger than that of mortgage‐backed CDOs. Furthermore, the return performance of CLO tranches has in general also been superior to the returns from the comparable leveraged loans upon which CLOs are based—though there are difficulties in measuring returns for CLO tranches since transaction prices are not public information, especially in the case of the equity tranche.After describing their remarkable growth, the authors focus on two fundamental risks posed by CLOs. The first risk relates to the reliability of credit ratings—though it's important to note that the extensive due diligence behind leverage loans versus mortgage loans effectively reduces CLO investors' reliance on the rating agencies. The second risk relates to the systematic risk borne by the CLO investors, which is lower than that of MBS if only by virtue of the fact that CLOs are based on shorter‐term floating rate instruments than 30‐year mortgages. More important, what happens in most MBS, CLO managers can actively manage their loan portfolios in the secondary markets, and effective and active management of collateral works to limit both default risk and the possible effects of systemic shocks.

Market discipline and regulatory arbitrage: Evidence from ABCP liquidity guarantors

We investigate whether the U.S. stock market disciplines asset-backed commercial paper (ABCP) liquidity guarantors who exploit a regulatory loophole that exempts at least 90% of the risk capital charge. We find that the market reduces liquidity guarantors’ franchise value when a short ABCP maturity causes the conduit credit losses to remain with guarantors rather than being transferred to investors. Banks with franchise value more sensitive to the ABCP guarantee cost maintain a higher risk capital buffer. We interpret our findings as evidence that market discipline–complexity of the shadow banking system notwithstanding–alleviates the consequence of regulatory arbitrage.

Shadow Banks and the Collateral Multiplier.

With an emphasis on contributing to macroeconomic pedagogy, we examine the collateral multiplier by comparing it to the traditional money multiplier in a simplified framework of traditional banking and shadow banking in which government bonds are the core assets. While the money multiplier is a measure of the ability of the banking system to intermediate sovereign debt by creating deposits, the collateral multiplier is a measure of the shadow banking system’s ability to intermediate sovereign debt by creating shadow money. It also measures the degree of reuse of sovereign debt as collateral. In this setup, the collateral multiplier is defined as the ratio between dealer banks’ matched book repo activity relative to their trading book. Using the New York Fed’s Primary Dealer Statistics data, we empirically estimate the collateral multiplier for US Treasury repo collateral. Our model and empirical results shed light on the transmission mechanisms of monetary policy channeled through shadow banks and on the US Treasuries market turmoil induced by COVID-19 in March 2020.

The Global Shadow Bank–Systematic Risk and Tax Policy Objectives: The Uncertain Case of Foreign Hedge Fund Lending to U.S. Borrowers and Transacting in U.S. Debt Securities

The structure of the global financial system has drastically changed in the last few decades with the rise of what has been called a shadow banking system. The term “shadow banking system” refers to the fact that financial institutions outside the traditional banking system have acted as intermediaries between investors and borrowers and have increasingly undertaken roles traditionally played by banks, including lending capital to U.S. businesses. These intermediaries have included investment banks, hedge funds, and others that have expanded liquidity in many global financial markets, arguably increasing market efficiency.

Financial Crises and Shadow Banks: A Quantitative Analysis

Motivated by the build-up of shadow bank leverage prior to the Great Recession, I develop a nonlinear macroeconomic model that features excessive leverage accumulation and show how this can cause a bank run. Introducing risk-shifting incentives to account for fluctuations in shadow bank leverage, I use the model to illustrate that extensive leverage makes the shadow banking system runnable, thereby raising the vulnerability of the economy to future financial crises. The model is taken to U.S. data with the objective of estimating the probability of a run in the years preceding the financial crisis of 2007-2008. According to the model, the estimated risk of a bank run was already considerable in 2004 and kept increasing due to the upsurge in leverage. I show that levying a leverage tax on shadow banks would have substantially lowered the probability of a bank run. Finally, I present reduced-form evidence that supports the tight link between leverage and the possibility of financial crises.