Shadow loans and regulatory arbitrage: Evidence from China

Xiaoxi Liu and Ilhyock Shim

Journal of Banking & Finance, 2024, vol. 160, issue C

Abstract: This paper examines how Chinese banks used on-balance sheet shadow loans for regulatory arbitrage and whether the financial market priced in the banks’ use of shadow loans and the resulting vulnerabilities in 2014–2022. It finds that banks chose to window dress their regulatory capital ratio by using shadow loans when their capital adequacy ratio was close to the regulatory minimum. It also shows that banks with a higher shadow loan ratio or a lower breakeven non-performing loan ratio obtained from reverse stress testing faced higher wholesale funding costs. Finally, after the announcement of a rare bank failure event, more vulnerable banks witnessed lower cumulative stock and bond returns.

Keywords: Bank capital regulation; Chinese economy; Regulatory arbitrage; Reverse stress test; Shadow banking (search for similar items in EconPapers)
JEL-codes: G12 G14 G21 G28 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (3)

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Working Paper: Shadow loans and regulatory arbitrage: evidence from China (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:160:y:2024:i:c:s0378426624000116

DOI: 10.1016/j.jbankfin.2024.107091

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