Chinese Shadow Banking: Understanding KRIs and risk scenarios

This paper is written by industry practitioners of the Hong Kong Chapter of the Institute of Operational Risk and the students from RMBISA of the Hong Kong University of Science and Technology.

Executive Summary

Shadow banking activities have grown rapidly in recent years, especially in China. With a view to gaining a greater understanding of financial activities in China, this paper provides an overview of the Chinese shadow banking system, including comparisons between the current situation and past financial crises. Scenario analysis also highlights the inherent risk within the financial system, while risk indicators and possible solutions are discussed.

An Overview of the Chinese Shadow Banking System 

The definition of shadow banking varies from one country to another. The Financial Stability Board defines shadow banking as “credit intermediation involving entities and activities outside the regular banking system”.

A Comparison between China and the U.S.

The shadow banking system in the US consists of securitized loans and obligations, as well as money market funds. In contrast, apart from engaging in direct credit extensions made by non-bank entities, China’s shadow banking system involves informal securitization through a “funding pool” provided by banks and has direct links to commercial banks. Furthermore, the banks act as important distribution channels for financial products designed by trust companies. With more than four decades of history, the U.S. shadow banking system is mature – even more so after the 2008 subprime mortgage crisis that tightened regulations and led to the implementation of greater supervision. In contrast, Chinese shadow banking has only a 4 to 5 year history, indicating the immaturity of the system, with its inherent high risk and lack of comprehensive regulations.

The Current Situation in China

A series of restrictive policies have been imposed by the China Banking Regulatory Commission (CBRC) since 2010, including the raising of the required reserve ratio (RRR), credit rationing and interest rate controls. As a result, different kinds of off-balance-sheet financing activities in banks have been indirectly encouraged. According to Credit Suisse’s analysis, core Chinese shadow banking products were estimated at RMB22.8 trillion (approximately US$3.72 trillion) at year-end 2012, accounting for 44% of China’s GDP in 2012. According to Standard & Poor’s, shadow banking credit in China has been growing at an annual rate of 34% over recent years.

Chinese Shadow Banking













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