Part 3: Does the government need to regulate the shadow banking system in China

In the previous study of Chinese shadow banking system, most scholars are focus on the question “to be or not to be of shadow banking system in China”, some of them think shadow banking system can bring the financial crisis, need to regulate the shadow banking system, the other think shadow banking system can accelerate financial reform, diversification of financial products, therefore, do not need to regulated.  However the Chinese government do not show it attitude of this question at the whole time.

In order to answer this question, it should base on the relevant data. However,  because this is a new topic in China, and the shadow banking system is not regulate by the centre bank, cannot get many official data, it makes this question hard to analysis. Although the Chinese centre bank made a new statistics of All-system Financing Aggregate in 2012, but it only available the data in January 2012, meanwhile, in this statistic, there do not have the relative data of informal financing institution, therefore, in the following part, the data that I used is based on some newspaper, probably do not have strong persuasion, but I will keep focus on the topic, and revise this blog.

There have a picture show us the growth of lending activities in China.

(source from: http://s.wsj.net/public/resources/images/OB-QG723_chinao_K_20111025111829.jpg)

By this picture, we can easily find the ratio of Chinese shadow banking system is keep increase, and in 2011, it has grown to 22% of all new financing in China, but the bank loans is still the main financing channels (click here see details). Compare with the ratio of shadow banking assets divided by the total bank assets 65% in the U.S. before 2008 financial crisis (6.5 trillion US$ of shadow banking assets, Timothy Geithner, 2008), there still have a huge gap.

However, this picture do not consider the informal financial sector, as the last blog said, form Jan.2011 to Jun. 2011, the scale of social financing increased by 7.76 trillion yuan, bank loans increased 4.17 trillion yuan, 53.7% of the total (click here see details), and 46.3% are from the shadow banking system. However in this statistic, it do not include the private lending, according to the statistic of Securities Daily, it estimate there have 3.38 trillion yuan provide by Private lending, it means in China, there have 6.88 trillion yuan increase by shadow banking system, 62.26% of the total, approaching the data 65% of the U.S. before financial crisis. Therefore, in my opinion, if the Chinese government do not want to recommit the same error like the U.S., it needs to regulate the shadow banking system. If not, I think the next financial crisis will be occurring in China. 

However, based on the high percentage of shadow banking assets and the special characteristics of Chinese shadow banking, the regelation of shadow banking system will be a hard work. If China wants to regulate the shadow banking system, it not only need to study the regulation method of other countries, but also need to connect the reality, and established some targeted regulatory programs.

Part2: The characteristics of the shadow banking system in China

In the last blog, I am talking about what is “shadow banking system”, however, after this week’s research; I suppose the shadow banking system I talked last week is a typical U.S. style. Compare with the shadow banking system in China, although the operation method are the same, but the project of the operation have a huge different.

Compare with the U.S. style shadow banking system and Chinese style. We can observe the following different.

1.      The formal financial sector

Chinese financial market is a typical mode of indirect financing, which leading by commercial banks. Although the develop speed of Chinese financial market is fast, but the capital market in China is still lag behind, the proportion of direct financing is still very low, it made the Chinese shadow banking system are still focus on the traditional bank financing business, few financial innovation like the western countries, therefore, the cooperation between commercial banks and trust companies become the major part of shadow banking system.

 2.      The informal financial sector

The another major part of shadow banking system is the private financing organizations, which include pawnshop, underground bank, private equity fund, civil RCAs and so on. According to the statistical report by People's Bank of China (central bank), form Jan.2011 to Jun. 2011, the scale of social financing increased by 7.76 trillion yuan, bank loans increased 4.17 trillion yuan, 53.7% of the total, in other words, 46.3% are from the shadow banking system, nearly half of the total.

As Lv (professor of Beijing university) said: The Chinese version of the shadow banking system is different from the Western developed countries’ traditionally defined, the main form is not securitization of real estate loan, is the "trust and bank cooperation", “underground banks” and other such financial form. (detail click here)

Part1: what is shadow banking system?

The shadow banking system is means the non-bank intermediate entities which excise banking functions but unregulated or less regulated by the financial regulators, which include in financial instruments and financial products, such as investment bank, hedge funds, private equity funds, Structured Investment Vehicle, Collateralized Debt Obligation (the reason of 2008 global financial crisis), Credit Default Swap, Asset-Backed Commercial Paper, Repo and so on.

Compare with the Traditional commercial banking system, there have huge different between these two "bank", after summarized of these different, I suppose there have three major different parts.

1. Source of fund

Although both the shadow banking system and the traditional commercial banking system are the intermediates between depositor and borrower, but the commercial bank can absorb deposits from the individual and firms, however, the shadow banking system cannot absorb deposits, and the source of fund are mainly from the financial markets, through short-term wholesale funding and debt to raise the funds, and then use the fund to the long-term investment. 

2. Regulation

The traditional commercial banks regulated by the Central Bank, need them to publish accounts, keep plenty of capital reserve, and severely restricted those commercial banks operate high risk behaviour. But the shadow banking system is outside the regulatory system, do not need to publish their accounts, do not have limit of capital reserve and the use of leverage, therefore, the shadow banking system have a significant competitive advantage in the financial markets. 

3. The ability of risks resistance

The commercial banks can get the protection of the central bank, when there faced emergencies like the bank run, it can get the financial support by the central bank. However, because the shadow banking system is outside the regulatory of central bank, therefore, they cannot get the protection of the central bank, meanwhile, based on the use of high leverage, if a run on these shadow banks, these shadow banks must bankrupt.  As everybody knows, the 2008 financial crisis was contributing by the shadow banking system.

Part 0: To be, or not to be: that is the question for shadow banking system

In the 2008 global financial crisis, the shadow banking system acts as a major role to produce the financial crisis. Therefore, in recent years, the financial regulators increase the supervision of the shadow banking system, and the term "shadow banking system" also appeared in the economic news and research papers more and more. In those articles, there has one attracted my attention, the Wall Street Journal’s paper. And the view point of this paper is:  Based on the Chinese shadow Banking System, the nest sub-prime will be occurring in China. Because China is my hometown, I really care about the future of my country; however in our class, the study of regulating shadow banking system is not detailed, therefore, in this blog, I will focus on the regulation of shadow banking system in China. Try to understand the following question: What is shadow banking system, the characteristics of the shadow banking system in China, does the government need to regulate the shadow bank in China, the regulation of Shadow Banking System in foreign countries, and the suggestion of Chinese government supervises and regulates the shadow banking system.

Before the main body of my blog, there have a video, can explain the relationship between the shadow banking system and the 2008 economic crisis faultlessly, hope have fun.

Some related articles and news


English articles (click the title, it will link to the paper)
Pozsar, Z. Adrian, T. Ashcraf, A. and Boesky, H. (2010) Shadow Banking, FederalReserve Bank of New York Staff Reports

Anon (2011). Shadow Banking: Scoping the Issues. A Background Note of the Financial Stability Board
Gorton, G. and Metrick, A. (2010) Regulating the Shadow Banking System. Research paper of Yale and NBER

Adrian, T. and Shin, H. (2009) The Shadow Banking System: Implications for Financial Regulation, Federal Reserve Bank of New York Staff Reports

Hu, Y. (2011) China Banks: Shadow banking conundrum, Research paper of HSBC


Chinese article
Li, S. (2011). Regulation of Shadow Banking System. Journal of China Bond.
Xin, Q. (2010) The Shadow Banking System. Taipei: Meilin Press Ltd.


News:
http://topic.eastmoney.com/financeearn/
http://www.bbvaresearch.com/KETD/fbin/mult/110821_Shadow_Banking_EN_tcm348-266397.pdf?ts=332012
http://doc.mbalib.com/view/215ed85d978d8d3cfcf531c8a754989a.html
http://doc.mbalib.com/view/314537b622402d6b95bb30abbbd7ea4f.html
http://blogs.wsj.com/marketbeat/2011/10/25/chinas-shadow-banking-system-the-next-subprime/
http://www.csstoday.net/Item/8264.aspx
http://finance.sina.com.cn/review/jcgc/20111209/113610965496.shtml
http://www.ftchinese.com/story/001041183
http://xb.21cbh.com/HTML/2012-1-26/1MMDAwMDI1OTI1Mg.html
http://www.51tot.com/n5842.html
http://news.xinhuanet.com/fortune/2011-05/31/c_121476544.htm