BIS Paper Examines Shadow Banking System in China
BIS published a working paper that analyzes money creation mechanisms of shadow banking tools in China, investigates their effects on financial risk, and surveys recent regulation. Using the balance-sheet information of 311 listed and non-listed banks from over a decade, the paper investigates the relationship between shadow banking credit and financial risks at both the macro and micro levels. It summarizes the shadow banking regulations implemented by Chinese regulators, discusses the related issues, and sets out policy implications. The paper also highlights the critical role of banks’ shadow in creating credit money and hiding the credit risk incurred by banks.
Regulatory arbitrage is believed to be a key driver for the emergence of shadow banking worldwide. The case of China is similar but more complex, given China’s unique banking regulations, such as regulated deposit and lending rates in addition to certain lending restrictions. Recent studies have focused on shadow banking as a unique feature of the financial system in China. Appendix B of the paper provides a list of shadow banking related regulations that have been announced or implemented by the authorities such as PBC, CBIRC, and CSRC. The main regulator of Chinese shadow banking is CBIRC, which coincides with the reality that Chinese shadow banking centers on banks rather than on traditional shadow banking, which channels funds through other types of financial institutions.
The paper clarifies the definition of shadow banking in China, decomposing it into banks' shadow and traditional shadow banking. It finds that, although banks' shadow drives up the credit risk of banks, banks have not adequately assessed that risk or taken the appropriate countermeasures. Banks' shadow impairs the effectiveness of banking regulations aimed at lending and leads to the accumulation of systemic risk. A resulting policy implication indicates that regulators should apply different restrictions to banks’ shadow and traditional shadow banking and focus on the balance-sheet items that banks may use to hide their shadow banking operations.
The paper proposes policy implications for both the traditional and shadow banking systems. First, appropriate regulation should be applied to the traditional banking system. To avoid an accumulation of shadow banking risk, regulators should avoid applying overly strict traditional policies to traditional banks. and should balance the pros and cons of the shadow banking system. Regulators may need to take measures to protect “shadow funds.” In terms of how to regulate shadow banking more effectively, guidance on general regulation and specific regulatory measures are critical. Current suggestions for regulation guidance include macro-prudential and countercyclical regulation in the Basel III framework, in addition to the functional and category-based regulation.
The paper concludes that, to strengthen supervision, regulators in China should closely track the evolution of various shadow banking channels, both on- and off-balance sheet. Specific macro-prudential regulation tools, such as asset reserves and risk reserves, should be applied separately to banks’ shadow and traditional shadow banking. In the future, the key to regulating the shadow banking system in China will be to strengthen the regulatory mechanism centered on banks. Both banks’ shadow and traditional shadow banking are intricately linked with the banking system and they draw on banks as the main funding source. The regulatory authorities should seek to enhance their macro-prudential management of the banking system to preempt future excessive growth of financial risks.
Related Link: Working Paper
Keywords: Asia Pacific, China, Banking, Shadow Banking, Credit Risk, Research, Market Based Finance, Macro-prudential Policy, Systemic Risk, BIS
Featured Experts

Dr. Samuel W. Malone
Sam leads the quantitative research team within the CreditEdge™ research group. In this role, he develops novel risk and forecasting solutions for financial institutions while providing thought leadership on related trends in global financial markets.
Previous Article
BCBS Consults on Guidelines on Prudential and AML/CFT SupervisionRelated Articles
APRA Finalizes Reporting Standard for Operational Risk Requirements
APRA finalized the reporting standard ARS 115.0 on capital adequacy with respect to the standardized measurement approach to operational risk for authorized deposit-taking institutions in Australia.
ESAs Issue Advice on KPIs on Sustainability for Nonfinancial Reporting
ESAs Issue Advice on KPIs on Sustainability for Nonfinancial Reporting
EBA Consults on Pillar 3 Disclosure Standards for ESG Risks Under CRR
EBA is consulting on the implementing technical standards for Pillar 3 disclosures on environmental, social, and governance (ESG) risks, as set out in requirements under Article 449a of the Capital Requirements Regulation (CRR).
EU Amends CRD4 and CRD5 as Part of Capital Markets Recovery Package
EU published Directive 2021/338, which amends the Markets in Financial Instruments Directive (MiFID) II and the Capital Requirements Directives (CRD 4 and 5) to facilitate recovery from the COVID-19 crisis.
EBA Publishes Single Rulebook Q&A Updates in February 2021
The EBA Single Rulebook question and answer (Q&A) tool updates for this month include answers to ten questions.
ESMA Releases Schema and Instructions for Securitization Reporting
ESMA updated the set of questions and answers (Q&A), along with the reporting instructions and an XML schema for the templates set out in the technical standards on disclosure requirements, under the Securitization Regulation.
EU Rule Amends Requirement for European Single Electronic Format
EU published Regulation 2021/337, which amends the Transparency Directive (2004/109/EC), regarding the use of the single electronic reporting format for annual financial reports.
EU Committee Recommends Systemic Risk Buffer of 4.5% in Norway
The Standing Committee of the European Free Trade Association (EFTA) recommended that a systemic risk buffer level of 4.5% for domestic exposures can be considered appropriate for addressing the identified systemic risks to the stability of the financial system in Norway.
PRA Clarifies Approach to Onshoring of Credit Risk Rules for UK Banks
In a recent statement, PRA clarified its approach to the application of certain EU regulatory technical standards and EBA guidelines on standardized and internal ratings-based approaches to credit risk, following the end of the Brexit transition.
FSB Sets Out Work Priorities for 2021
In a recently published letter addressed to the G20 finance ministers and central bank governors, the FSB Chair Randal K. Quarles has set out the key FSB priorities for 2021.