Here's how China's shadow banking sector evolved over the years

The regulators and financial institutions seemingly have played a “Whack-A-Mole” game, says BBVA.

Shadow banking activities have grown rapidly over the past several years in China. BBVA Research estimates that the volume of shadow banking assets amounts to 83% of GDP and 27% of total banking assets as of end-2016.

"The growth trajectory of China’s shadow banking sector has been shaped by two contrasting forces: financial institutions’ strong incentive to increase their profit through product innovation and the regulators’ uncoordinated and intermittent efforts to curb them. To a certain extent, the regulators and financial institutions seemingly have played a “Whack-A-Mole” game. Thus far financial institutions seem to outwit the regulators in terms of ever-growing size of the shadow banking sector," BBVA said.

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The financial institutions’ efforts to circumvent regulations have led to a plethora of business models in the shadow banking sector, including: Wealth Management Products (WMPs), trust company products, entrusted loans, bank acceptances, private lending, microfinance loans, Trust Beneficiary Rights (TBRs), etc.  

However, the majority of these shadow banking activities are bank-centric in nature. In general, banks partner with non-bank financial institutions (NBFIs) to channel funds that are raised from off-balance-sheet product issuances (for example, WMPs), to the capital market and (or) the real sector.

Another feature of today’s shadow banking sector is the increasing complexity of the structure as some shadow banking business models tend to intertwine with each other. For example: traditional bank depositors can purchase WMPs for higher investment returns. Then banks invest the proceeds collected from WMPs in other shadow banking products - trust beneficiary right (TBR) or even other WMPs etc.

The issuers of TBR and WMPs, which are generally non-banking financial institutions (NBFIs), could either reinvest the funds in capital markets (such as money market, stock, bond or derivatives), or extend loans to the borrowers in the real sector, including property developers, SMEs and local government financial vehicles (LGFVs) etc. As a result, the bank-centric structure of the shadow banking sector has significantly lengthened the chain of financial intermediation between the depositors and final fund users.

It is also noted that the prosperity of shadow banking activities occurred in the context of China’s financial liberalization. Part of shadow banking activities also functions to boost growth by lowering financing costs for those small-medium-sized-enterprises (SMEs) whose fund demand have long been neglected by the formal banking sector and capital markets. In the meantime, the shadow banking activities also enrich the financial products in the market and provide more available investment vehicles for households to park their ever-increasing savings.