By Ba Shusong, Research Institute of Finance of DRC

Research Report No 17, 2013 (Total 4266)

Recently, with bank financial products becoming a hotspot topic in China, the shadow banking has become a concept of common concern. In fact, the definition, connotation and meaning of the shadow banking given by the international financial circle are closely linked with the economic and financial structures, different stages of financial development and financial supervision environments of various economies.

I. Connotation and Features of the Shadow Banking

Paul Allen McCulley, managing director of Pacific Investment Management Company (PIMCO), was the first to put forward the concept of shadow banking in 2007. Currently, the international financial supervision organizations have generally agreed on the concept. According to Shadow Banking: Scoping the Issues, a research report published by Financial Stability Board (FSB) in April 2011, shadow banking refers to "a system of credit intermediation that involves entities and activities outside the regular banking system, and raises systemic risk as well as regulatory arbitrage concerns." Factors for the shadow banking to trigger systemic risks mainly include: maturity mismatch, liquidity transformation, credit risk transfer and high leverage.

Although FSB has defined the shadow banking and described its features clearly, the structures of the shadow banking are varied due to the variety of financial structures, different development stages of financial markets and financial supervision environments of various countries. The shadow banking system of the United States mainly includes the credit intermediation system conducted through risk diversification and leverage enlargement centered on securitization of money market funds such as investment funds and investment banks, whereas shadow banking in Europe mainly includes investment funds like hedge fund and securitization trading activities. Few similar entities are found in China's present financial system like those holding a dominant position in the shadow banking in developed European countries and the United States.

People in the financial circle have made a multi-dimensional study of the shadow banking from different perspectives to correspond to the present Chinese financial market, which generally includes four scopes：the narrowest scope, which makes shadow banking to only involve bank financing business and trust companies; the narrow scope, which involves bank financing business and such non-bank financial institutions as trust companies, finance companies, auto financing companies, financial leasing companies and consumer finance companies; the wide scope, which involves such form-based business as the narrow scope, inter-bank business and entrusted loans, as well as such non-bank financial institutions as financing assurance companies, petty-loan companies and pawnshops and so forth；the widest scope, which includes the wide scope and the private lending. This paper selects for discussion the narrow scope that draws the highest attention and is currently the most prevalent, namely, the non-bank financial institutions such as bank financing business and trust companies as the so-called Chinese shadow banking.

II. Shadow Banking in China Is Different in Nature from the Shadow Banking in Europe and the United States

Based on above-mentioned definition and feature description, and in line with the performance of the shadow banking system in the international financial crisis, scoping the shadow banking should mainly include the following three aspects: First, whether shadow banking is brought into the regular financial supervision system. Before the financial crisis, shadow banking in the United States and Europe, such as the hedge fund, had not been monitored to the full and, propelled by such financial innovations as counter purchase and asset securitization, such institutions had constantly expanded their balance sheets to realize their low-cost and high-risk operations. Second, whether shadow banking is characterized by maturity mismatch and high-leverage operation, and thereby may cause high individual risks. During the financial crisis, the shadow banking liabilities in the United States and Europe were focused on short-term wholesale finance, such as the inter-bank lending and commercial bills, but investments were made in protracted and poorly mobile assets such as assets backed securities, thus bringing about a serious maturity mismatch. Before the crisis, the balance sheets of the major US investment banks had expanded drastically, even with the average leverage scoring a 40-fold increase or so and, during the crisis, the ferocious de-leverage effect also quickened the substantial slump of the asset prices. And third, whether shadow banking is of relevance and infectiousness, which will thus make the advent of systemic risks possible. Before the crisis, the shadow banking system had correlated with the commercial banking system by means of business contact and equity investment in Europe and the United States, spreading the crisis-incurred risks quickly from the shadow banking system to the traditional commercial banking system and thus bringing about systemic risks. According to the above-stated three aspects, although the driving force behind the emergence of the shadow banking system in China is basically aimed at the regulatory arbitrage and is also characterized by liquidity transformation and credit risks, and although some risk control links should be strengthened, the shadow banking system has been brought under the regular supervision system on the whole and is not typically characterized by the high leverage and the maturity mismatch that may trigger systemic risks and, meanwhile, the size of the said system and its risks have not yet produced any huge impact on systemic risks.

Firstly, the shadow banking system is still being financially monitored in China. At present, the bank financial products fall within the statistical requirements enforced now by supervision departments, the performance of the financial products issued by commercial banks should be submitted to supervision departments at regular intervals, and the particulars of the financial products should also be submitted to the central bank to bring into the scope of the aggregate social financing. The Interim Measures on Management of Personal Financial Services with Commercial Banks promulgated in 2005 and the Measures on Management of Sales of Financial Products of Commercial Banks implemented in 2012 are the regulatory frameworks for bank financial services. Supervision departments have also exercised rigorous management over trust companies, including access management and capital regulation (Measures on Management of Net Capital of Trust Company demands that the trust companies' net capital-to-risk capital-ratio should surpass 100%). Constrained by such rules and regulations as the Measures on Management of Finance Companies of Enterprise Groups, the Provisional Measures on the Assessment of Indicators Monitoring Risks of Finance Companies of Enterprise Groups, the Measures for the Implementation of Administrative Approvals for Non-Bank Financial Institutions, the Measures on Management of Auto Financing Companies and the Pilot Measures on Management of Consumer Finance Companies, the supervision companies, with reference to the regulatory requirements over commercial banks, have set up a complete set of prudent regulatory systems over related non-banking financial institutions.

Secondly, China's shadow banking system is not characterized by marked high leverage and mammoth maturity mismatch. Capital pool for regular bank financial products should be administered independently and relevant information should be disclosed fully to match every sum of funds with corresponding assets and to enable each earnings to cover the risks on the whole(According to Wind data, the anticipated annual rate of return on banks' present 3-month financial products is around 4.6%, being lower than the short-term 6-month loan interest rate of 5.6%, and within the same 6-month period, the rates of return on national debts and central bank bills are about 2.7% and 2.9% respectively; according to SB, an American-funded security trader, only less than 10% of the financial products yield an interest rate higher than 5%). Hence, risks of financial products should be basically close to those of similar investment products issued under publicly-offered funds within the regular supervision system. In terms of the project assets for which the financial management funds make way, the time limit for over 90% of the assets is generally within 5 years, and the degree of maturity mismatch is equivalent to that of traditional commercial banking. For trust companies, currently trust companies in China should not operate on borrowings and cannot give loans to banks either, and therefore have no conditions for leverage-based operation. Meanwhile, the trust funds are being operated in a seal-off way, demanding a consistency in investment duration and project duration. Therefore, high leverage and maturity mismatch are not the features of the trust funds.

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