China’s Shadow Banking Sector: Wealth Management Products and Issuing Banks

Viral V. Acharya, Jun Qian, Zhishu Yang
Aug 09, 2017



Since the 2007–2009 financial crisis, an extensive strand of research has focused on how a shadow-banking sector has arisen in the financial system as a result of "regulatory arbitrage" by banks in the form of off-balance sheet activities or by non-banking entities that are entirely unregulated or lightly regulated compared to banks. Due to the opaqueness and complexity of this sector, shadow banking is more difficult to monitor and is often deemed to increase the overall fragility and risk of the financial system. Much of this literature focuses on developed economies (see e.g., Acharya and Oncu (2013) for a review).

There is little research studying shadow banking in emerging markets, including what many believe to be a large sector in China, currently the largest economy (in purchasing power parity terms) in the world. Rising risk in the global financial system has been attributed to turbulence in China’s stock market, with the shadow-banking sector reportedly providing much of the leveraged capital that fueled the market bubble during the first half of 2015. In this paper, we examine a large component of China’s shadow banking—wealth management products (WMPs) issued by the largest twenty-five banks.

We separate the banks into two categories: the largest four state-owned banks ("Big Four" banks) and the other 21 banks ("Small- and Medium-sized Banks" or SMBs). The Big Four banks are among the largest financial institutions in the world and are controlled by the central government (See Note 1).  They have branches across different parts of the country and are the predominant players in the financial system including the deposit, loan, and interbank markets. The SMBs are much smaller in size and many concentrate their business in certain regions.

During 2008–2014, China’s central bank—the People’s Bank of China (PBC)—set ceilings on bank deposit rates that changed over time but were usually below market rates (SHIBOR). Banks faced on-balance-sheet lending restrictions including capital ratio requirements and loan-to-deposit ratio (LDR) limits; loans could not exceed 75% of total deposits. With these regulations, profit-seeking banks pursued unregulated or less regulated activities, most notably in the form of WMPs, to benefit from the difference between regulated deposit rates and market lending rates. By offering higher interest rates than the regulated rates on deposits, WMPs help banks attract more savings, and principal-floating products can move loan assets off their balance sheets.

While WMPs have been in existence for years, the size of this segment, especially principal-floating products issued by SMBs, began to take off at the end of 2011; this tremendous growth has continued to the present. In a companion paper, Acharya, Qian, and Yang (hereafter AQY (2016)) link the growth of this sector to the 4 trillion RMB stimulus plan initiated by the Chinese government in response to the global financial crisis in 2008.  Because the Chinese economy was booming at the time, the stimulus was initiated due to external pressure (e.g., pleading from the U.S.) and did not result from internal economic conditions. To support this massive stimulus, the "Big Four" banks issued huge volumes of new loans and also raised deposits so as to fulfill the LDR requirements for on-balance-sheet lending.

However, the Big Four responded to and supported the stimulus plan to different extents, with the Bank of China being the fastest expanding Big Four bank, thus creating a plausibly exogenous shock in the local deposit market to SMBs facing competition from the Big Four banks. While all four banks have branches throughout the country, the intensity of their branching across regions varies. Using information on all banks' branch openings and closings at the city level, AQY (2016) find that SMBs significantly increased the issuance of WMPs after 2008, with the scale being greater for banks more constrained by on-balance-sheet lending and with more geographic exposure to local branches of the Bank of China (and who thus faced a greater likelihood of losing deposits). The size of WMP issuance is also greater when banks have a higher LDR, especially during times when the regulated deposit rate is much lower than the market rate.

AQY (2016) also find that SMBs take on substantial rollover risks when issuing WMPs. We find that many WMPs have short maturities—one quarter or less—and they mature toward or at the end of a quarter when the CBRC calculates and monitors LDRs. Because many buyers of WMPs are also bank depositors, when WMPs mature, the funds are typically put back in the deposit account with that bank (albeit temporarily) and can help banks decrease LDR. On the other hand, some investment projects that are financed by the WMPs, such as those in real estate and infrastructure, pay off in much longer horizons. Therefore, banks, especially SMBs, need to issue new WMPs to meet redemption of matured products and refinance loan assets. When there are more WMPs due in a quarter, SMBs offer significantly higher yields on the new WMPs in order to raise funds and manage liquidity needs.

Big Four banks also raised the scale of WMP issuance during the second half of 2008–2014. This action was in part their response to the WMP issuance by SMBs. The action also could have been related to problems in the implementation of the stimulus, as a large fraction of the newly created bank credit went to real estate and local infrastructure projects, leading to rising leverage and risk in those sectors and local governments. The PBC began tightening credit supply to these sectors in 2010. With restrictions in making new loans and to avoid defaults on these long-term projects—many owned by local governments—Big Four banks issued WMPs, especially principal-floating products, to refinance these projects.

WMPs also affect banks’ behavior in the interbank market. Big Four banks, as the main players in the interbank market, are willing to borrow at higher interest rates when they have a greater amount of WMPs due. At the aggregate level, the one-week SHIBOR closely tracks the aggregate amount of maturing WMPs issued by the Big Four banks during the sample period. Finally, AQY (2016) look at the stock market response in times of (interbank market) credit crunches for the 17 listed banks. When the cost of interbank funds unexpectedly rises, we find that stock prices drop more for banks with more WMP maturing. This indicates that investors and the market seem to be aware of the rollover risk of issuing banks.

Overall, the results from AQY (2016) demonstrate that the swift rise of China’s shadow banking seems to have been triggered by the massive stimulus plan, and it has contributed to the greater fragility of the banking system.

There are at least two important differences between the U.S. shadow banking sector and its counterpart in China. First, the process of moving debt obligations from institutions’ balance sheets and packaging and re-packaging them into structured products make these products complicated and opaque in the U.S. By contrast, most of the WMPs offered by Chinese banks (at least those studied during 2008-2014) are simple, short-term fixed income products. Second, after institutions sell the loans and other (unpackaged) debt to underwriters, there is still some connection between the structured products and the originating institutions in the U.S. But in China, the link between the WMPs and their issuing banks is very tight.

Overall, the growth of the WMPs in China more closely resembles the growth of money markets in the U.S. as a result of Regulation Q, and, more recently, the growth and collapse in the issuance of asset-backed commercial paper (Acharya, Schnabl, and Suarez (2013)).

Note 1: They are the Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Bank of China (BOC), and Agricultural Bank of China (ABC). See Allen, Qian, and Qian (2005) for a review of the Chinese financial system, and Qian, Strahan and Yang (2014) for a review of China’s banking sector.

The views presented in the paper are those of the authors, and do not represent those of the Reserve Bank of India. The authors are responsible for all the remaining errors.

(Viral V. Acharya, New York University, and the Reserve Bank of India; Jun Qian, Fanhai International School of Finance, Fudan University; Zhishu Yang, School of Economics and Management, Tsinghua University.)

Acharya, Viral V and Sabri Oncu, 2013,"A Proposal for the Resolution of Systemically Important Assets and Liabilities: The Case of the Repo Market," International Journal of Central Banking, 9 (1), 291-350.

Acharya, Viral V, Jun Qian, and Zhishu Yang, 2016, "In the shadow of banks: Wealth management products and issuing banks’ risk in China," working paper, New York University (

Acharya, Viral V, Philipp Schnabl, and Gustavo Suarez, 2013, "Securitization without Risk Transfer," Journal of Financial Economics, 107, 515-536.

Allen, Franklin, Jun Qian, and Meijun Qian, 2005, "Law, Finance, and Economic Growth in China," Journal of Financial Economics 77, 57-116.

Qian, Jun, Philip Strahan, and Zhishu Yang, 2015, "The Impact of Incentives and Communication Costs on Information Production and Use: Evidence from Bank Lending," Journal of Finance 70, 1457-1493.



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