Shadow banking, implicit guarantees, and risk-taking

Shen Guo and Zheng Jiang

Macroeconomic Dynamics, 2025, vol. 29, -

Abstract: This paper investigates the welfare implications of the rise of shadow banking in China, driven by regulatory arbitrage and implicit guarantees. Although shadow banking can improve social welfare by relaxing constraints on banks’ capacity to expand credit, it may also hurt social welfare due to the risk-taking behavior induced by implicit guarantees. We study the optimal level of guarantees and shadow banking in a model that balances these benefits and costs. Our findings suggest that reducing the existing degree of guarantees and shrinking the shadow banking sector could enhance social welfare in China.

Date: 2025
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