Relationship between Shadow Banking and Real Estate Bubble in China

The Evergrande crisis coming to light has caught media attention the world over and raised a bigger question about the Chinese housing bubble. Real estate, though having quasi-financial status attached to it, has a special appeal in China due to the lack of other savings or investment sources and socio-cultural reasons. Both direct and indirect flow of funds have been witnessed in property for investment or speculative purposes, at times through households and at other times through new financial channels like REITs and Private Equity.Currently, there’s a divergence between the actual market price of housing assets in China and their intrinsic or fundamental value. The phenomenon is in congruence with that of an asset bubble which has many a time busted and led to major financial crises like the Asian Financial crisis in 1997 and the Subprime mortgage crisis in 2007–2008, sending chilling tremors around the global financial markets.Loose monetary policy is often credited with inflated asset prices. But, despite China restricting credit supply, the anomaly of rising real estate prices can be owed to another ecosystem that has mushroomed parallel to the formal financial sector — that of shadow banking working independently of the monetary policy. The informal financial channels have boosted the economic growth of the country while insulating the dominant formal financial sector from the risks of asset price crashes. This chapter is an attempt to have a deeper understanding of the impact of such an asset bubble crash and whether it would be temporary in nature and can be contained domestically or not.