What is 'shadow banking'? Does it pose a threat to the stability of China's financial system?
Decoding Shadow Banking from Financial Stability Board
The report presents information about the Chinese business and growth of the shadow-banking sector in China during the recent times. The shadow banking in China has been growing largely due to the huge impact of Government campaigns against the financial leverage. This has also prevented the lending by people, and the bond financing has reduced as well. The shadow banking of China is a kind of credit transition where various banking entities are involved along with banking operations that are not similar to the normal banking system of China. From the last few years, the PBOC and financial regulators have also supported the shadow-banking sector to reduce the chances of risks in the financial system of China as well as obtain short-term rates of interest. This would furthermore reduce the leverage in the bond market and manage proper funding and investments within the Chinese business sector (Adrian et al. 2012). All these issues have been kept into consideration and thus the various measures taken by the financial institutions have allowed the debt dependent individuals who borrowed money to take help from the shadow banking sectors.
Based on the various financial reports by the Financial Stability Board, the shadow banking is considered as reliable and effective for managing the financial practices, which may create lesser risks within the banking sector. The shadow banks are not limited to bank loans of deposit rates, and it prevents the high-cost PBOC requirements of reserve too. Two of the most important products of shadow banking in China are trusted products and wealth management products.
According to the Financial Stability Board, shadow banking is a kind of observable fact where the transition of credit is possible with the consideration of banking entities and banking activities that are outside the regular banking system. It is effective and reliable for enabling a transformation of credit and manages liquidity. The shadow banks also face similar kinds of issues like other banks related to the credit, maturity, transforming liquidity, etc. There is a lack of security for these shadow banks like the publicly guaranteed deposit insurance and lender of banking facilities from central banks. There is lesser number of regulatory requirements too, which further can be open to risks regarding financial stability. There are no such guarantee systems for managing deposits in banks, though the Government plays a helping hand in such cases for ensuring the protection of bank deposits. Therefore, from the perspective of Financial Stability Board, the shadow banking is effective for managing the practices, which are of low risks and can include mutual funds (Adrian et al. 2012). Though there might be market-related risks, the shadow banks had provided economic benefits and also enhanced the growth in the economy by making the financial services available at lesser prices for the consumers, when compared to other financial institutions.
Though there are some advantages of shadow banks, the flexibility and price competitiveness may lead to expenditure for the margins of safety. The financial institutions need more capital and liquidity than the shadow banks. This is often expensive, though it is a safer aspect and many of these shadow banks have allowed customers to borrow money in some risky situations as well. The collateral protection required by a bank can also allow the shadow banks to operate with lesser rules and regulations for controlling the risky situations with ease (Board and Financial Stability 2012). Therefore, with the numerous benefits also, the shadow banks are less safe because of its lack financial stability like other banks.
Outlining the main causes of rapidly growing of shadow banking in global financial markets after global financial crisis
The shadow banking system is an essential part of the financial sector that provides products and services, which can separate the shareholders from the management of investments, thus harder to evaluate the value of making investments and risks. It is a though a benefit, still, this lack of transparency has increased the chances of risks for the financial system and may even result in another global financial crisis, as the happened in 2008. The shadow banks include private equity funds, hedge funds, mutual funds, pension funds, etc. The causes of shadow banking could be growth in gross domestic product or GDP, a lower rate of interest, increase in investments by shareholders and stringency of bank capital. There are many banks, which have run into caps on the volumes of lending and due to this, PBOC loan quotas have created limitations for banks to lend as much as is needed (Cheng, Yip and Yeung 2012). The banks in China have also faced difficulties in gaining deposits to finance and increase loan.
The China Banking Regulatory Commission (CBRC) is a public organisation, which has been authorised by the State Council for managing the banking sectors present in the administrative regions. To handle the increased debts, lack of transparency and other issues like less capital, the Government of China has formed the CBRC for managing the banking activities and ensure proper financial transactions with ease and efficiency (Yang and Wenhui 2012). The main functions of China Banking Regulatory Commission are to maintain rules and regulations and supervise the banking activities through maintenance of draft laws, rules regarding administration and present proposals for amendments. The CBRC also can make approval of the amendment and manage termination along with providing punishment to those who have been found carrying out unlawful behaviors (Gennaioli et al. 2013). This regulatory body in China can also identify the qualifications of senior managers of shadow banks and furthermore analyse the statistical reports for handling issues related to deposit banking. The CBRC also has the role of enabling routine management of boards that supervise the state owned banking institutions (Tong and Chee Kiong 2014).
The CBRC consists of various departments including the General Affairs Office, Policy and Regulation Department, first, second, third departments of banking supervision, supervision department for non-banking financial institutions, control department for co-operative financial institutions, statistic department, accounting, personnel, masses work, publicity and working department consisting of the supervisory boards. The General Affairs office manages the coordination of work on an everyday basis and prepares to draft documents, form conferences and ensures that the data and information in documents are kept confidential and secure. The policy and regulation department develop proposals for the policies related to the shadow banking industry and furthermore organise the banking reform programs (Kolstad, Ivar and Arne Wiig 2012). This department can also gather relevant information about issues faced and prepare the release statements too. The three departments of banking supervision enable management of business activities and financial transactions and even punishing the concerned party in case he is found guilty for wrong doings. The supervision department for non-banking financial institutions I responsible for supervising the non-banking financial institutions by following all the rules, regulations of draft properly by managing risks related to assets and liabilities ratio, financial payments, etc (Lin et al. 2014).
Determining the function of China Banking Regulatory Commission
The growth and development of shadow banking in China since the year 2010, has brought a greater impact on the economic conditions after the global financial crisis in the year 2008. Due to the huge network of non-bank financial activities, a huge financial crisis was caused which resulted in financial instability. This also led to the creation of credit at a rapid rate from the year 2010, and there was also a lack of transparency that was found in the non-banking activities and balance sheet. There are various reasons for which banks have been pressurized, and there has been a growth of shadow banking in China financial system. There are caps on the lending done by people considering the People's Bank of China or PBOC. There are also other constraints such as the limitation of bank loans, which are deposited at 75 percent. The financial regulators have discouraged individuals from lending money to various industries, and there is less amount of capital present within the non-bank channels. Due to this, there is need for fulfilling the financial requirements to manage a healthy liquidity rate (Liu 2013). These were not subjected to any limitations within bank on loans or rates of deposits, which also helped in establishing shadow banks. The growth of shadow banks in China also prevented expensive PBOC reserve requirements, which further maintained a healthy financial status all throughout.
There are few issues as well because the shadow banks do not work like other regular banks and have lesser margins of safety, because of which there might be certain difficulties in making economical adjustments as well as allow transparency. The growth of shadow banking has helped the Central Government of China and the entire financial system to remain in a good position for dealing with the financial crisis, which was suffered previously, and ensure that no such situation occurs again (Liu, Yang and Ying Ying 2014). The shadow banks have tie-ups with the major banks, and thus the owners of shadow banks have sufficient fiscal ability to handle financial crisis and prevent little central government debt to gross domestic product or GDP ratio.
The financial risks have resulted due to the volatile or rapidly changing stock market in China. The financial risks are related to the connection between the financial markets and financial institutions in China. The equity market also has increased to more than 150 percent in the last few years and this has resulted in rapid growth as well. The volatility was higher than the peers, which further led to creating issues such as less profit and lack of growth in the economy too. Other financial risks include an increase in housing prices as well as real estate loans. The amount increased from 3.7 trillion Yuan to nearly 18 trillion Yuan in the year 2017 (Teik-Cheok Loy and Johnben 2012). China has developed various campaigns for reducing the number of high debts and focus on the reduction of $3 trillion shadow banking sector. This would utilise the most critical sources of income for the banks and utilise those for funding purposes within the bond market. According to the various data and information presented, WMPs have been kept aside from the balance sheet, thereby making it difficult for the financial regulators to determine the shadow banking sector's stability and furthermore ensure growth and development within the banking sector (Menkhoff, Thomas and Magnus Lars Bengtsson 2012). There are also new rules and regulations, which have made the lenders to preserve the capital properly and ensure that the potential losses are avoided anyhow from the WMPs. It is also a major problem of creating a link between the financial institutions and banking activities, which can also be deceptive during a financial crisis. There is no such guarantee of bank deposits, and it poses a serious threat while protecting bank deposits and maturity transformation (Shanlang, Lin and Wu Jian 2012).
Evaluating the growth of shadow banking in China financial system
The SWOT analysis of shadow bank in China has helped in determining the strengths, weaknesses, opportunities and threats. China’s shadow bank is considered as an example, and information about various financial aspects has been obtained, based on which, the SWOT analysis has been done. The strengths include Group Corporation's ability to gain in-depth knowledge and connect various market segments to draw in more customers. It has an active client based structure that helps in ensuring integrity, transparency and professionalism within the company. The workers are highly skilful and possess relevant knowledge on international banking (Riasi and Arash 2015). The weaknesses of the shadow-banking sector are low ROA and ROE, and the deposit franchise is weak when compared to other banking sectors in China. It also is less safe for keeping money in accounts though some scopes and opportunities have been provided by the Central Government of China such as the development of new macroeconomic policy and increase in investments made in the fixed assets in China even during the financial crisis. The Government of China has also created various campaigns for enabling anti-corruption and manage more investments, which would, in turn, bring out more spending by the consumers. Few threats include the availability of financial services online with the use of internet, inappropriate recovery if the economy of the United States and competition from other banking sectors (Schwarcz and Steven 2012).
The primary causes of the growth of shadow banks are the rise in caps on the lending quantity, which was imposed by the PBOC or People's Bank of China. There was also a limitation of bank loans to deposit of 75 percent, which also created the risks while the financial regulators de-motivation on lending created more scopes for the development of shadow banks in China. The non-banking sectors were suffering from lack of capital and needed certain things to fulfill the requirements of managing proper liquidity rate. The shadow banks, when introduced created better scopes for people to lend money as well as allowing avoidance of expensive reserve requirements of PBOC. The definition of shadow banking from the perspective of Financial stability board has been illustrated here along with the major causes of the growth of shadow banking. The functions of China Banking Regulatory Commission and growth of shadow banking in the financial system of China were also included. The report concluded with a proper evaluation of SWOT analysis of Shadow banks in China and financial risks related to the financial intermediation and shadow banking.
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