Regulatory arbitrage, shadow banking and monetary policy in China

Vo Phuong Mai Le, Kent Matthews, David Meenagh, Patrick Minford, Zhiguo Xiao

Research output: Journal PublicationArticlepeer-review

Abstract

Regulatory arbitrage is a persuasive explanation for the rapid growth in shadow bank credit. In China, the distortions caused by government support to state-owned enterprises (SOEs) and preferential lending by state-owned banks have created an environment for the development of shadow banks that lend to small and medium enterprises (SMEs). The imposition of a loan-to-deposit ratio (LDR) cap of 75% in 2009–2015 gave an additional boost to the growth of shadow bank credit by providing an incentive for conventional banks to bypass regulation and lend to SMEs via the shadow banks. The result is that shadow bank credit varied contra-cyclically to regular commercial bank credit in response to monetary policy shocks, dampening the effectiveness of monetary policy during the period of the LDR cap. This paper presents a model of the Chinese economy using a DSGE framework that accommodates a banking sector which isolates the effects of lending to SMEs by shadow banks. The model which is estimated by the method of indirect inference, allows for bank and shadow bank lending to affect the credit premium on private investment. We show that in general regular bank credit and shadow bank credit varies pro-cyclically with monetary policy but varies contra-cyclically when a LDR cap is imposed. The findings have implications for the policy of de-leveraging followed by China.

Original languageEnglish
Article number101640
JournalJournal of International Financial Markets, Institutions and Money
Volume80
DOIs
Publication statusPublished - Sep 2022

Keywords

  • China
  • DSGE model
  • Indirect Inference
  • Shadow Banking

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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