The Potential Crisis, the Increased Shadow Banking in China?

China, as a representative country of emerging market, plays a more significant role in the global financial market. Consequently, Chinese financial market experienced a dramatic change with improving financial liberalization in the past decade. Diversified derivatives and Chinese unique financial character accelerate the developing speed of maturity of the financial market indeed. However, the invisible risk contained in shadow banking threat the processing of Chinese financial market to some extent, the possibility of shadow banking's collapse is increasing resulted by aggressive blast rising scale of shadow banking.

As we discussed in the last post, the property of shadow banking determines the high risk existed in the associated financial chain. Compared with the particular characteristics of USA's shadow banking, the shadow banking system in China has some distinguishable properties, which indicates the background of specified country could influence the shadow banking (story here). So we attend to find out the particular differences by comparing the component contained in shadow banking.

 Firstly, the main content of shadow banking in USA is based on the financial innovation, for instance,asset-backed commercial paper, structured invest vehicles, subprime mortgage and so on. In contrast, the main operation contained in shadow banking of China is off-balance sheet activity of  formal banking and unregulated private finance, which denotes the shadow banking are associated with national economy. Under the specified condition, Chinese economy is experiencing a mode change, it means the growth of economy is hardly predicted and the investors are facing a default risk due to the shadow banking.

Secondly, the participators in shadow banking are quite different. In USA, the main players in the system are non-financial institutions, such as, investment banks, hedge fund, bonds and insurance companies. On the other hand, the main participators in China are commercial banks, private companies and underground loan institutions. This characteristic determines the hardness of regulation on shadow banking in China to some extent. The graph depicts the main components in the shadow banking system of China.

Lastly, in China, the regulation institution still does not have a specified definition of shadow banking, but actually the scale of Chinese shadow banking is increasing dramatically. Deutsche Bank estimates that the scale of Chinese shadow banking was 21 trillion yuan, equivalent to 40% of the GDP (story here). The need of define the detail operation of shadow banking and establish specified regulation is really pressing. If the government could not handle the problem properly, the consequence must be incredible and horrible for the global economy.

As usual,  we share a video taking about the particular condition of shadow banking industry at last, really do hope my blog can offer an interesting concept of shadow banking to some extent. 

The Past Crisis Era, Invisible Risk and Strict Regulation for Shadow Banking?

Based the collapsing of American housing market, the associated derivatives were crashed. These derivatives mostly were defined into the shadow banking system, which drawn attention of the government and normal individuals. Moreover, the invisible risk of shadow banking was faded its cover by public, people attend to assess the magnitude of risky coefficient for different financial product belong to the shadow banking system. The scale of shadow banking was influenced to a large extent consequently.The figure depicts the changing trend in the period from 2002 to 2011, it explicitly denotes there is a huge discrepancy between the increasing speed before 2007 and that of which after 2007.

Particularly, for the USA market, the shadow banking is not the nominally traditional banking,  but it plays the similar role indeed as the traditional banking which typically offer financial bridge combining borrowers with lenders. Before the financial crisis, the shadow banking substitute the traditional banking as the mediation in the subprime loan. Moreover, shadow banking issue diversified derivatives with high leverage, combine different financial products and sale them to whole investors. Consequently, it resulted the cumulative financial risk chain which is volatile and fragile. High leverage, volatility, informational closure and lack of regulation, all these factors cause that shadow banking  breeds potential risk. 

Thus, in the past crisis era, not only the USA government but also other developed countries' government realize that regulation is the core part to secure the shadow banking system. They established diversified policy to define the detail of shadow banking's operation explicitly, which reduce the opportunity of inside operation and monitor the behavior of managers of varied financial institution included in the shadow banking system. For example, Goldman Sachs has been renamed as a bank holding company Goldman Sachs Group Inc, is also due to get a strong government bailout, but was included in the regulatory areas.

The video below is introducing the exigent need for regulating banking and reducing the high potential risk.    

 

As above said,  the high risk in shadow banking drawn attention from government and institutions, avoid the potential financial risk become the mail task for each government focus on establishing a healthy financial market. Shadow banking would not been remove from the market, but it would be under a strong regulation and a highly disclosure environment. 

Thus, in the next post, I would like to introduce a hot topic recently, which is the risk of  dramatically increased shadow banking in China would lead a second financial crisis?

Demon or Angel? The Properties and Influence of Shadow Banking

As we mentioned before, the increased shadow banking system has a huge influence that cannot be ignored on the financial market. What is the remarkable properties of shadow banking? More importantly, does it stimulate  the speed of improving the financial market, or it interrupts the  stable financial system by infusing incredible risk caused by over leverage? What is the proper attitude to this naughty thing? Only through addressing these questions, we can explicitly know the shadow banking and how to manage shadow banking rationally.

Demon or angel?

Via reviewing the development history of  shadow banking in USA, it is not too hard for us to find some distinguishable characters for shadow banking. From 1960 to 1970, a credit crisis crashed USA and  some other developed countries, which was called disintermediation type credit crisis. It resulted a series of incredible crash on these countries' economy,  for instance, lack of the liquidity of institution; credit crunch; declined the variables financial firms' profitability; a huge scale of bankruptcy and so on. Due to this circumstance, the government established quite lots of reactions, which included reducing  the regulation and constraints focusing on the financial firms, this environment caused the basic character of original shadow banking which is regulation vacancy. 

However, the regulation vacancy resulted the trend of issuing variable derivatives and the dramatic increase on the scale of shadow banking, on the other hand this property also caused the incredible and invisible risk that can not be ignored. Besides, there are some other basic characteristics of shadow banking: First, the source of funds is impacted by the liquidity of capital market; Second, because the deposits are not included in their asset and liability statement, which means shadow banking is out of the traditional regulation on banking or similar institutions.Third, the lack of regulation causes the shadow banking typically has a high leverage during their operation, this property was thought as the insensitive factor for the financial crisis in 2008. 
From the normal individuals' or investors' perspective after financial crisis, shadow banking was a cancer to the healthy financial system, the diversify derivatives are the main factors causing the financial crisis. Some radical views think we should replace the shadow banking system with other financial innovations. However, from my perspective, the shadow banking  stimulates the developing of  whole capital market to some extent, especially when other traditional banking system was struggling in the specified conditions. Now the shadow banking system is continuous shrinking with the process of deleverage, but it would not be the demise, as the shadow banking is a important component in whole financial market. The future of shadow banking will be a high information disclosure and financial regulation to make sure that shadow banking can be a healthy part, this assumption has been confirmed by some government's measures. The news below just is tiny support for this proposal.

     

As above concept explained, the main characteristics of shadow banking dominate the framework of the system and cause some incredible influence on the whole financial market. Due to the special position of shadow banking, we need to consider it more cautiously and critically. So in the next post, the main risk and homologous regulation would be the topic, this may explains why shadow banking can always be under the spotlight.

Fade the Cryptic Mask of Shadow Banking

Due to the financial crisis's incredible influence on the global economy and normal individuals, the shadow banking system fades its mystery mask slowly. To some extent, the shadow banking system really accelerated the financial crisis processing. So what is a rational attitude to the shadow banking system? Should central banks or treasury adopt more regulation on monitoring shadow banking and what is the proper regulate steps?

Firstly, let's  take a little time on denote the definition of the shadow banking system, shadow banking  also can be defined as shadow financial system or shadow banking system normally. This definition was proposed by Paul Mcculley, who is the executive director of Pacific Investment Management Company. After Paul Mcculley's naming, shadow banking was received by public in past few years. Then, the Financial Stability Board (FSB) defines shadow banking as “credit inter-mediation involving entities and activities outside the regular banking system”, but other authors give complementary definitions that emphasize different aspects of shadow banking. 

For example: 

1. Adrian and Ashcraft (2012) say it is “a web of specialized financial institutions that channel funding from savers to investors through a range of securitization and secured funding techniques”. 
2.  Poszar, Adrian, Ashcraft and Boesky (2012) put special emphasis on the similitudes and differences between traditional banking and shadow banking explaining that they carry out similar functions but that “shadow banks [unlike] traditional banks lack of access to public sources of liquidity such as the Federal Reserve’s discount window, or public sources of insurance such as Federal Deposit Insurance” (reference here).

From the definition from FSB, we can explicitly find the character of shadow banking is out of regular banking system, which means it is not under the traditional banking regulation. The dramatic increase of the scale of  shadow banking was caused by incredibly attractive profit based on lack of regulation. The shadow banking system has played an irreplaceable role in the financial market.
However, comparing with the concept of traditional banking, the shadow banking is still mystery for the most individuals. Here is a video explaining what is shadow banking. 

Then, does shadow banking really murder healthy economy and what is the magnitude of the influence caused by shadow banking? Next post could explain these issues to some extent. 

First day for my blog

Hello, everyone.   It is so glad that l have a blog today.
Here is sentence that has enlighten me and hope it will give you some common sense as well:
A friend in need is a friend indeed.
One year here to study is too short for me but l still appreciate the precious chance to be together with friends who come from various countries and experience fascinating life in Queen's University Belfast.