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Shadow Banking in China: An Opportunity for Financial Reform



"The Chinese economy has experienced explosive growth in debt since 2009: total gross debt reached 282% of GDP in 2014, comparable to the developed economies. Particularly striking was the increase in non-financial sector corporate credit. Non-bank lending played a significant role in that build-up. In this important volume, the authors bring this complex and opaque system into the light and put it under a magnifying glass. They identify the opportunities for expanded equity and debt funding of businesses that will drive growth in the rapidly evolving Chinese economic structure. But they also highlight the risks of improperly priced risk, poor credit cultures, implicit guarantees relying on the state balance sheet, and lax regulation. It is essential reading for those seeking to understand the evolving structure of the financial system in China and the key reforms that are urgently required at this stage."
—A. Michael Spence, Nobel laureate; Professor of economics, New York University Leonard N. Stern School of Business

"How serious is China's shadow banking issue? What Chinese characteristics does it have? Will it trigger the next financial crisis in China or globally? What policy measures should be adopted to address the risks in the shadow banking system? These are among a few of the most important questions examined in this book entitled Shadow Banking in China: An Opportunity for Financial Reform, edited by Andrew Sheng and Ng Chow Soon. This important book not only puts recent developments in China's shadow banking sector into proper perspective and context and identifies key Chinese characteristics underpinning the rapid growth of Chinese shadow banks, but also offers fresh insights on the interconnectivities and vulnerabilities at the sectoral level. It also provides useful policy recommendations at the macro and structural levels. The analyses are solid and comprehensive, and the conclusions are insightful and useful. I strongly recommend this top quality book to any reader interested in gaining a deeper understanding of the key risks rooted in China's shadow banking and how to sort them out, from the academic, policy and investment perspectives."
—Haizhou Huang, Managing Director, China International Capital Corporation

"Andrew Sheng, an experienced regulator with a complex systems view of finance, leads a team that investigates and sheds light for both Western and Eastern thinkers on the shadows (banks) of the Chinese financial markets. Read, learn, and marvel at how Sheng's creative mind, rigorous observation, and deep insights rise to the challenge to diagnose the fault lines of financial instability and to prescribe remedies to manage the dangers of these mysterious financial innovations in China."
—Robert Johnson, President, Institute for New Economic Thinking (INET); Senior Fellow and Director, Franklin and Eleanor Roosevelt Institute

"Rapid financial and technological innovation is entangling regulators everywhere in an ongoing game of 'whack-a-mole' as they struggle to keep pace with burgeoning developments in shadow banking. Nowhere is this more true than in China, and nowhere are the information flows more opaque. Sheng and Ng's study is a must for those trying to seek truth from facts."
—Simon Ogus, Founder and CEO, DSG Asia Limited

ANDREW SHENG is chief adviser to the China Banking Regulatory Commission, former chairman of the Securities and Futures Commission, Hong Kong and deputy chief executive in HKMA.

NG CHOW SOON is the former director of the governor's office, Bank Negara Malaysia and a Harvard Mason Fellow.

Foreword by Victor Fung ix

Foreword by Liu Mingkang xiii

Acknowledgments xv

About the Editors xvii

Executive Summary xix

Key Findings and Policy Recommendations xxii

CHAPTER 1 Introduction 1
Andrew Sheng

1.1 References 16

CHAPTER 2 Shadow Banking in the Global Context 17
Cathleen Yi Tin

2.1 Introduction 17

2.2 What is Shadow Banking? 18

2.3 Size of the Global Shadow Banking Industry 20

2.4 Factors for the Rise in Global Shadow Banking 23

2.5 Interconnectedness Between Shadow Banks and the Formal Banking Sector 26

2.6 The Nature of Shadow Banking Differs Across Countries 28

References 32

CHAPTER 3 Shadow Banking within the National Balance Sheet 35
Jodie Hu and Andrew Sheng

3.1 Introduction 35

3.2 Overview of the Chinese National Balance Sheet 37

3.3 Who Owes What in China’s National Balance Sheet? 44

3.4 Zooming in on China’s Sectoral Balance Sheets 47

3.5 Shadow Banks within the National Balance Sheet 74

3.6 Evaluation of the National Balance Sheet Approach 74

3.7 Basic Analytical Conclusions and Policy Recommendations from the NBS Approach 78

References 80

CHAPTER 4 Shadow Banking with Chinese Characteristics 83
Wang Yao

4.1 Introduction 83

4.2 Nature and Scale of Shadow Banking in China 86

4.3 Factors Spurring the Growth of Shadow Banks in China 98

4.4 Different Channels of China’s Shadow Banking 105

4.5 Interconnectivity between Shadow Banking and the Official Banking System 119

4.6 Shadow Banking’s Impact and Regulatory Implications 121

4.7 Conclusion 129

References 129

CHAPTER 5 Inherent Risks in Chinese Shadow Banking 133
Wang Yao and Jodie Hu

5.1 Introduction 133

5.2 Getting to the Heart of the Problem - the Underlying Asset Quality 137

5.3 Non-Financial Corporate Sector (excluding Real Estate Companies) 140

5.4 Real Estate Companies 149

5.5 Local Government Financing Platforms (LGFPs) 154

5.6 Non-performing Assets in the Shadow Banking System 161

References 168

CHAPTER 6 Impact of Technology on China’s Financial System 171
Li Sai Yau and Cathleen Yi Tin

6.1 Introduction 171

6.2 The Rise of e-commerce in China and its Implications 173

6.3 The Rise of e-finance in China and its Implications 175

6.4 The Role of Technological Innovation in China’s Transformation 185

6.5 Rethinking Conventional Financial Regulation and Development 187

6.6 Implications for the Financial Services Industry 190

6.7 Conclusion 191

References 192

CHAPTER 7 Implications for Reform Agenda 195
Andrew Sheng

7.1 Introduction 195

7.2 Ongoing Shadow Banking Reforms in China 198

7.3 Financial Reforms - Looking Beyond Shadow Banking 201

7.4 Immediate-Term Reform Priorities - Diagnosis and Damage Control 202

7.5 Loss Allocation - Medium-Term Measures 204

7.6 Mapping the Future of China’s Financial System: A Potential Long-term Blueprint 208

7.7 Conclusion and Suggestions for Future Research 213

References 214

CHAPTER 8 Conclusion 217
Andrew Sheng

8.1 Introduction 217

8.2 Shadow Banking with Chinese Characteristics 220

8.3 Unique Opportunity for Reform 222

8.4 Reform Agenda Going Forward 223

8.5 Immediate-term Reform Priorities 224

8.6 Long-Term Reforms: A Financial Blueprint 224

APPENDIX A Evolution of International Financial Crises - Lessons for China 227
Li Sai Yau

A.1 Introduction 227

A.2 Comparing the Evolution of International Financial Crises 228

A.3 The Subprime Mortgage and ESDC Crises: Lessons for China 234

A.4 International Comparison of Nonperforming Loans (NPLs) 235

A.5 Conclusion 244

References 244

Index 247