The Economics of Shadow Banking: Lessons from Surrogate Intermediaries in China∗

The shadow banking sector has grown tremendously in China in the last decade, developing in parallel with the rise of non-bank lenders in western economies. Chinese non-financial firms supply credit in the shadow banking sector, i.e., they behave as “surrogate intermediaries”. Using hand-collected data on the entrusted loans made by listed firms to other firms, this paper analyzes the causes and consequences of this phenomenon. Deposit funding declines and therefore constrains loan growth differentially across banks, as banks have to comply with the 75% loan-to-deposit ratio restriction. Using the pre-determined geographic variation in the presence of constrained banks, I find that entrusted lending is more prevalent and more profitable in cities where traditional bank loans grow slower. Entrusted lenders also appear to use existing cash rather than raise external finance to make the loans. Overall, my results suggest that this segment of shadow banking fills the regulation-induced gap in bank loan supply and is unlikely to undermine financial stability. Please find the latest version here. ∗I am incredibly grateful to Robert Engle, Robert Whitelaw, Jennifer Carpenter, Philipp Schnabl, and Viral Acharya for their invaluable guidance. I thank Cameron Peng, Kinda Hachem, Kose John, Holger Mueller, Alexi Savov, Anthony Saunders, Siddharth Vij, Russell Wong, and Ayako Yasuda for their insightful comments, and I am grateful to seminar and conference participants at the Richmond Fed, NYU Stern, Columbia (student), and the Doctoral Student Consortium at the 2017 FMA Annual Meetings for their questions and discussions. The financial supports from the Becker Friedman Institute and the Richmond Fed are greatly acknowledged. All errors are my own. †Email: [email protected]. Address: 44 West Fourth Street, Ste 9-197B, New York, NY 10012 USA.