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Federal Reserve Bank of Atlanta
FRB Atlanta Working Paper
What we learn from China's rising shadow banking: exploring the nexus of monetary tightening and banks' role in entrusted lending
Kaiji Chen
Jue Ren
Tao Zha
Abstract

We argue that China's rising shadow banking was inextricably linked to potential balance-sheet risks in the banking system. We substantiate this argument with three didactic findings: (1) commercial banks in general were prone to engage in channeling risky entrusted loans; (2) shadow banking through entrusted lending masked small banks' exposure to balance-sheet risks; and (3) two well-intended regulations and institutional asymmetry between large and small banks combined to give small banks an incentive to exploit regulatory arbitrage by bringing off-balance-sheet risks into the balance sheet. We reveal these findings by constructing a comprehensive transaction-based loan dataset, providing robust empirical evidence, and developing a theoretical framework to explain the linkages between monetary policy, shadow banking, and traditional banking (the banking system) in China.


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Kaiji Chen & Jue Ren & Tao Zha, What we learn from China's rising shadow banking: exploring the nexus of monetary tightening and banks' role in entrusted lending, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper 2016-1, 01 Jan 2016.
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Keywords: Regulatory arbitrage; asset pricing; institutional asymmetry; entrusted loans; risk taking; shadow loans; bank loans; nonloan investment; nonbank trustees; small banks; large banks; balance sheet; optimal decisions
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