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Regulatory arbitrage, shadow banking and monetary policy in China

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  • Phuong Mai Le, Vo
  • Matthews, Kent
  • Meenagh, David
  • Minford, Patrick
  • Xiao, Zhiguo

Abstract

Regulatory arbitrage is a persuasive explanation for the rapid growth in shadow bank credit. In China, the distortions caused by government support to state-owned enterprises (SOEs) and preferential lending by state-owned banks have created an environment for the development of shadow banks that lend to small and medium enterprises (SMEs). The imposition of a loan-to-deposit ratio (LDR) cap of 75% in 2009–2015 gave an additional boost to the growth of shadow bank credit by providing an incentive for conventional banks to bypass regulation and lend to SMEs via the shadow banks. The result is that shadow bank credit varied contra-cyclically to regular commercial bank credit in response to monetary policy shocks, dampening the effectiveness of monetary policy during the period of the LDR cap. This paper presents a model of the Chinese economy using a DSGE framework that accommodates a banking sector which isolates the effects of lending to SMEs by shadow banks. The model which is estimated by the method of indirect inference, allows for bank and shadow bank lending to affect the credit premium on private investment. We show that in general regular bank credit and shadow bank credit varies pro-cyclically with monetary policy but varies contra-cyclically when a LDR cap is imposed. The findings have implications for the policy of de-leveraging followed by China.

Suggested Citation

  • Phuong Mai Le, Vo & Matthews, Kent & Meenagh, David & Minford, Patrick & Xiao, Zhiguo, 2022. "Regulatory arbitrage, shadow banking and monetary policy in China," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 80(C).
    • Handle: RePEc:eee:intfin:v:80:y:2022:i:c:s1042443122001123
    DOI: 10.1016/j.intfin.2022.101640
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    References listed on IDEAS

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    More about this item

    Keywords

    DSGE model; China; Indirect Inference; Shadow Banking;
    All these keywords.

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General

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