Shadow banking and financial development: Evidence from China

Shadow banking is a new financial system that has recently become an important innovation for stimulating economic development in the Western economies. Shadow banking has developed outside the regulatory system, entailing certain risks. Due to its expanding scale in recent years, shadow banking now has the potential to impact financial development that cannot be underestimated or ignored. In contrast to the Western economies, shadow banking has emerged in China as a a supplement to traditional commercial banking: trust loans, entrusted loans, undiscounted bank acceptance bills, etc. Meanwhile, shadow banking in the U.S. financial market creates currency to a certain extent. Some view the continuous expansion of shadow banking as a negative impact on China’s financial development, potentially destabilizing the traditional financial system. Others believe that both shadow banking and the existing financial system mutually beneficial. We use relevant data for China from January 2011 to February 2019 to analyze the relationship between shadow banking and financial development by establishing a vector autoregression model. Specifically, we find that an expansion of shadow banking promotes currency creation. This finding bodes well for the guidance of China’s future policy for its capital markets.