Abstract:
Using samples of entrusted loans, this paper investigates how shadow banking works in China from the perspective of formal credit cycle. The paper shows that entrusted loan, one type of shadow banking, is a market reaction to credit shortage: firms are more likely to participate in entrusted loans, and issue more entrusted loans when credit crunches. Further evidences show that, on one hand, the probability and the size of loans borrowed by non-state-owned enterprises are significantly increased when credit crunches; on the other hand, entrusted loans tend to flow to the province who has bigger credit shortage when credit crunches. In addition, the default probability of entrusted loans is significantly higher than the non-performing loan ratio of commercial banks. Moreover, compared with state-owned enterprises, the default probability of entrusted loans obtained by non-state-owned enterprises is relatively higher. These results indicate that entrusted loan is a market solution to credit shortage. The credit crunches have encouraged the capital flow to financial constrained regions and enterprises via entrusted loans, while also exacerbating the risk of shadow banking. This paper sheds light on the literatures of shadow banking and helps us to understand the role of shadow banking in China's financial system and its risk implications, which is important for shadow banking supervision.
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