The Rise and Decline of China’s Shadow Banking Subject to a Deleveraging Policy

Various circumstances have contributed to the development of the unregulated part of China’s banking sector since the 1980s and explain the rapid development of China’s shadow banking system after the GFC. Some examples are China’s relatively strict banking regulations, inadequate credit supply related to credit demand, lack of financial regulatory expertise and oversight, and a contraction of credit offered by the traditional financial institutions. Today's Chinese shadow banking not only differs greatly from its origins and earlier stages of development, but is also different in nature compared to the shadow banking systems in Western countries. Chinese shadow banking is primarily oriented toward domestic financial markets and has become a central element of China’s financial transformation, which is very similar to the US, where shadow banking is an integral part of the financial system. Unlike the US shadow banking system, in the Chinese system, the non-bank financial institutions are strictly interconnected to the traditional banks, and credits provided by shadow institutions in China are more complex, more sophisticated, and riskier compared to other Chinese markets. The general nature of the Chinese shadow financing is very risky, and the risk can be easily passed on to the participating entities. In consequence, many regulatory initiatives were undertaken in China during the last decade to reduce the role of shadow banking on the Chinese economy. Despite these initiatives, the problem of risky shadow banking in China has not been resolved and further regulatory initiatives related to this unregulated part of the Chinese financial market are expected in the near future.