Implicit guarantees and the rise of shadow banking: The case of trust products

Implicit guarantees provided by financial intermediaries are a key component of China's shadow banking sector. We show theoretically that project screening intermediaries, accompanied their implicit to investors, can be the second-best arrangement and mitigate capital misallocation favors state-owned enterprises (SOEs). Using dataset trusts’ investment products, we find, consistent with our model, ex ante expected yields reflect borrower risks guarantee strength, risk sensitivity is reduced strong guarantees. Regulations in 2018 restricting lead weaker relationship between yield spread more credit rationing non-SOEs.