Research of the Chinese Shadow Banking System:
What it is? How would it affect us? How should we treat it?

Chen Zhu

Econ 4597.01

Instructor: Bruce Bellner

Date: 02/26/2014

Abstract In this paper, the main topic would be the Chinese shadow banking system. This paper would develop the thesis from three aspects: the different definition for Chinese shadow banking system, compared to the U.S. shadow banking system, positive and negative effects of shadow banks have over the market, solution for the problem it brought to us. It may contain some facts with no back-up, and under such a circumstance, these numbers would be an estimate.

Key Word: Chinese shadow banking, pros and cons, solution for shadow banking’s problem

Research of Chinese Shadow Banking System In the past half of the year, after the boost of the Shibor at June, the Chinese debt crisis and shadow banking risks seems to become the hot topic among the presses. Some presses showed their pessimistic view of the Chinese government and enterprises debts, like the Bridging the fiscal chasm (2014) from Economist, a typical news addressing the pressure of the localities debt. The part of their pessimistic mood came from the fast growing Chinese shadow banking system. For these presses, they might misunderstand the whole system of Chinese economy, and the status of the shadow banking system in this economy. As a socialism country with a really different economic system from west, the old way to view the shadow banking activities may need some alternation under such an environment. In this paper, the Chinese shadow banking system would be introduced as follows: the definition of “Chinese shadow banking”, compared to the U.S. shadow banks, the pros and cons, and rightness of its existence, and finally how should we treat it in the future.

1 What it is?
1.1 U.S. shadow banks First what is the shadow banking system? By the IMF definition, the term “shadow banking” refer to a bunch of non-bank financial institutions that operate with banking functions yet out of regulatory – Many financial institutions that act like banks are not supervised like banks (Kodres, 2013), such as the SIV (structured investment vehicles), varied financial companies, and hedge funds, to provide liquidity to the market. The basic process of the typical shadow banking activities would be as follows:
First, loan origination (that of auto loans and leases, or non-conforming mortgages, for example) is performed by finance companies which are funded through commercial paper (CP) and medium-term notes (MTNs).
Second, loan warehousing is conducted by single- and multi-seller conduits and is funded through asset-backed commercial paper (ABCP).
Third, the pooling and structuring of loans into term asset-backed securities (ABS) is conducted by broker-dealers’ ABS syndicate desks.
Fourth, ABS warehousing is facilitated through trading books and is funded through repurchase agreements (repo), total return swaps or hybrid and repo/TRS conduits.
Fifth, the pooling and structuring of ABS into CDOs is also conducted by broker-dealers’ ABS syndicate desks.
Sixth, ABS intermediation is performed by limited purpose finance companies (LPFCs), structured investment vehicles (SIVs), securities arbitrage conduits and credit hedge funds, which are funded in a variety of ways including for example repo, ABCP, MTNs, bonds and capital notes.
Seventh, the funding of all the above activities and entities is conducted in wholesale funding markets by funding providers such as regulated and unregulated money market intermediaries and direct money market investors (such as securities lenders). In addition to these cash investors, which fund shadow banks through short-term repo, CP and ABCP instruments, fixed income mutual funds, pension funds and insurance companies also fund shadow banks by investing in their longer-term MTNs and bonds. (Pozsar & Adrian & Abscraft & Boesky, 2010, p 12-14)
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