A Preliminary Study of China's Shadow Banking Issues: Taking the 2020 China Shadow Banking Report as an Example

Chun-Kit (Kitson), Ng; Candidate LLM Student at Boston University, School of Law.

China's shadow banking system has expanded dramatically since the 2008 international financial crisis, causing widespread concern. In December 2020, a report by the Policy Research Bureau of the China Banking and Insurance Regulatory Commission conducted an in-depth study of China’s shadow banking problem for the first time. The following is a summary of the report's contents:

?

The Origin and Evolution of Shadow Banking

1. The Proposal of Shadow Banking

??????????? American economist Paul McCulley first proposed the concept of shadow banking in 2007.

??????????? McCulley believes that many financial activities operate outside the traditional banking system, and their actual functions are the same as those of banks, posing systemic risks to the financial system.

??????????? When it was proposed, it was only describing a phenomenon in the financial system and did not attract enough attention.

?

Main Characteristics of Shadow Banking

1.????????????? Non-bank Financial Institutions are the Main Carriers

·????? The broadest definition of shadow banking is that non-bank financial institutions are the main carriers. Any non-conventional banking financial institution engaged in related businesses can be included in the scope of shadow banking.

2.????????????? Functionally Plays the Role of Risk Conversion in Financial Assets

·????? Early attention on shadow banking focused on its financial intermediation function, emphasizing its role as a credit intermediary.

·????? Shadow banks often act as translators of credit, liquidity, and maturity risk factors.

3.????????????? Major Hidden Dangers that Pose Systemic Risks

·????? Shadow banking not only has the credit intermediary function of conventional banks but also mainly provides financing to entities outside the scope of conventional banks and may involve entities with poor credit levels and high default probabilities.

·????? Because its business spans multiple markets and industries, it lacks transparency and can easily become a source of systemic risks.

4.????????????? Free from Supervision

·????? Shadow banking is generally not subject to prudential and conduct regulation, nor is it included in the external bailout system.

·????? The lack of regulation makes it the only means of self-rescue, but its self-rescue capability is limited due to insufficient capital and reserves.

?

This part summarizes the origins and promoters of shadow banking, as well as its characteristics in the financial system, emphasizing the systemic risks it may pose and the problems caused by the lack of supervision.

?

The Composition and Evolution of Shadow Banking

?

Three Models Defined by Shadow Banking

1.????????????? Funding Source Model

·????? Based on the source of funds for financial activities as a distinction criterion, activities whose funds come from non-bank institutions are included in the scope of shadow banking.

·????? The advantage is that the data standards are unified, and the history is long, but the disadvantage is that the economic essence of business activities is not considered.

2.????????????? Financial Stability Board Model

·????? Define two standards: wide caliber and narrow caliber. The wide caliber is basically the same as the funding source model. The narrow caliber is mainly based on the judgment of economic functions and focuses on credit intermediaries that may threaten financial stability.

·????? Introduce a “two-step approach”: first, count shadow banks with a wide scope, and secondly, count shadow banks with a narrow scope by focusing on risk characteristics.

3.????????????? Non-core Liability Model

·????? The International Monetary Fund proposed, trying to break through the limitations of formal characteristics, that any other financing activities that are different from conventional bank deposit and loan business models can be counted as shadow banking.

·????? It has reference significance for Chinese bank-centered shadow banking system.

The development history of China’s shadow banking

?

1.???? From the early 1980s to before 2008: Non-bank financial institutions such as trust companies and insurance companies were established, and various institutions mainly developed around their own business scope.

?

2.???? After 2008: Following the international financial crisis, monetary policy became moderately loose, and financial institutions removed rigid constraints on credit scale. To avoid supervision, banks moved a large amount of assets off-balance sheet, leading to the rapid growth of various cross-market and cross-industry shadow banks.

?

3.???? 2013: Non-standard assets invested in bank financial management accounted for 27.49% of all financial management. Regulatory authorities issued notices to regulate the financial services of commercial banks.

?

4.???? 2013-2017: Internet financial products and online P2P loans suddenly emerged, and the third-party Internet payment market grew significantly.

?

The main characteristics of China’s shadow banking

?

1.???? Bank-centered: China’s shadow banking has "bank centralization characteristics" and differs from the shadow banking structure in developed economies.

?

2.???? Regulatory arbitrage is common: Taking advantage of imperfect regulatory systems and inconsistent standards, various institutions engage in regulatory arbitrage activities in the "gray area," leading to many instances of "driving without a license."

?

3.???? Rigid redemption expectations: Most products promise to maintain capital or minimum returns and have rigid redemption expectations. Insufficient information disclosure and low transparency.

?

4.???? Profit from channel fees: China’s shadow banking products are mainly loan-like products, and charging channel management fees is the main profit model.

?

5.???? Outstanding credit risk: Bank-led, customer rating standards are significantly lower than those for loan customers, leading to greater credit risk.

?

Shadow Banking as Defined by the Financial Stability Board

1.????????????? Two-Step Method

Broad scope: Develop a comprehensive understanding of the overall scale of shadow banking through statistics.

Narrow scope: By focusing on the risk characteristics of wide-scope shadow banks, separate statistics are made for narrow-scope shadow banks.

2.????????????? Scale of Shadow Banking

At the end of 2020, the balance of wide-caliber shadow banking was 236.44 trillion yuan, and the balance of narrow-caliber shadow banking was 150.47 trillion yuan.

The two totaled about 386.91 trillion-yuan, accounting for 87.02% of the assets of national financial institutions.

4.????????????? The role of shadow banking in Chinese financial system is gradually increasing, with potential systemic risks.

3.????????????? Evolution of Shadow Banking

3.1? The overall scale has increased overall.

·????? Since 2016, the scale of shadow banking has shown an overall upward trend, reaching a peak in 2020.

·????? Reasons for the increase in scale include rising demand for credit instrument financing, slowing growth in the real economy, and different understandings of standard definitions by financial institutions.

3.2? The scale of a single institution grows.

·????? In the field of shadow banking, the scale of a single institution has grown, and the monopoly effect of financial institutions has become prominent.

·????? In 2020, the top five financial institutions in shadow banking accounted for 40.42% of the total balance of wide-caliber shadow banking.

3.3? ?Risk characteristics are relatively prominent.

·????? The risks of shadow banking are mainly reflected in three aspects: credit, liquidity, and interest rate.

·????? In 2020, the overall risk of shadow banking is relatively stable, but the risks of individual financial institutions are more prominent, and there are potential risks.

3.4? ?Regulatory progress of shadow banking

3.4.1????? The regulatory system is gradually improved.

·????? In 2018, the China Banking and Insurance Regulatory Commission conducted regular supervision of shadow banking for the first time.

·????? In 2020, the China Banking and Insurance Regulatory Commission will strengthen supervision in scale management, business management, capital management, risk management, and information disclosure by promoting dual control of the total amount and quality of shadow banking risks.

3.4.2????? Dual control of total risk and quality

·????? Control the total amount of risks and guide financial institutions to scientifically and rationally allocate funds through integration, selection of the best, and prudence.

·????? Risk quality control, by improving the risk management level and strengthening credit risk, liquidity risk, and market risk management.

3.4.3????? Further advancement of standardization and specifications

·????? Improve the risk quality control mechanism and guide the expansion of the scope of wide-caliber shadow banking, which will help comprehensively respond to shadow banking risks.

3.4.4????? Strengthen capital supervision.

·????? Strengthen capital constraints on shadow banking and improve risk management levels.

·????? Strengthen risk awareness and prevent risk spread.

?

In Conclusion

The report concluded that China's shadow banking system has some problems in terms of scale, risk, and supervision, which require great attention. The China Banking and Insurance Regulatory Commission will further improve the shadow banking supervision system, comprehensively respond to shadow banking risks, and ensure the stable operation of the financial system by promoting dual control of the total amount and quality of risks, strengthening standardization and regulation, and strengthening capital supervision.

?

?

Bibliography

?

1.???? 中国银行保险监督管理委员会工作论文CBIRC WORKING PAPER, 中国影子银行报告,?? China Shadow Bank Report, December 2020 Issue 9, 2020年12月.? https://www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=947343&amp%3BitemId=934&amp%3Bgeneraltype=0 (Last visited on 29 November 2023)