Abstract: Issues related to shadow banking are so complicated that it confuses many practitioners from the financial sector even today. Rather than discriminating against this sector, a more active, positive and supportive approach should be adopted in order to guide the industry to develop in a more market-oriented way.
From the perspective of capital supply and demand, and the development of capital market, the deposit and loan model of commercial banks can hardly meet the development needs of the real economy, for which a variety of financing models in the capital market such as financing provided by shadow banking are very crucial.
From the perspective of counter-cyclical macroeconomic adjustment, the shadow banking industry could further expand under proper regulation, or at least should be allowed to grow moderately in proportion to China's economic growth.
Issues related to shadow banking are so complicated that it confuses many practitioners from the financial sector even today. I want to talk about my understanding of shadow banking from the following three perspectives.
First, the relationship between shadow banking and the liberalization of interest rate.
I used to have exchange with a Chinese commercial bank many years ago. And at that time, banks were most eager to cope with two pressures: the first pressure came from financial disintermediation, and the second was from the liberalization of interest rate. From the perspective of development strategies of banks, the two were indeed associated with the survival of commercial banks. Financial disintermediation is bound to put pressure on the on-balance-sheet businesses of commercial banks, while interest rate liberalization means narrowing spread of interest rates, which will affect banks' business operations.
There is a natural connection between interest rate liberalization and financial disintermediation. Recently, the central bank took the lead in releasing the new LPR (Loan Prime Rate) mechanism. Previously, it also launched a mechanism in which points are added to the MLF (Medium-term Lending Facility) rate to improve transparency for quoting. But the question is who should be the main driving force of the process of marketization of interest rate? Should it be the central bank or market itself as a result of factors like financial disintermediation?
It can be found from the process of the liberalization of interest rate in the US that a fully liberalized interest rate is largely based on financial disintermediation. Many financial products in the US have been created under financial disintermediation instead of based on benchmark interest rates for deposits and loans. By 1993, the Federal Reserve had also realized that the deposit and loan benchmark interest rate would be unnecessary which thereby was cancelled.
In fact, shadow banking in the US used to play an indispensable role in the process of the marketization of interest rate. In contrast, in China, it appears that the financial market is moving away from financial disintermediation and paying more attention to bank's lending business.
Therefore, in my personal view, the development of shadow banking should not be discriminated in the process of interest rate liberalization. Instead, a more active, positive and supportive approach should be adopted in order to guide the industry to develop in a more market-oriented way. But relevant regulatory measures have to keep up in the meantime.
Second, the relationship between shadow banking and capital supply and demand and the development of capital market.
The business of shadow banking is something that traditional financial institutions cannot do, which involves what some regulators regard as part of the "virtual economy" such as the real estate sector and over-capacity. This reflects the problem of insufficient financial supply in China.
Currently, the central government has proposed to promote the structural reform of the financial supply side. From my point of view, this has emphasized the need for more diversified entities to provide financial products and services, rather than "eliminating" the financial supply side.
After years of development, China's capital market still failed in reaching expectation, which is really confusing. To a large extent, shadow banking is connected to the capital market. Objectively speaking, the deposit and loan model of commercial banks cannot adapt to the complicated and ever-changing real economy. Commercial banks are limited by the issue of maturities. Their funds are short-term and cannot meet the needs of long term. Moreover, the investment behavior of commercial banks is mostly based on historical data. They lack the ability to timely respond to emerging commercial activities. In this case, capital market financing, including shadow banking, is still critical.
Third, the relationship between shadow banking and counter-cyclical macro regulation.
There is a saying within the industry that supervision should be an institutional setting, instead of a tool for counter-cyclical macro regulation. However, objectively speaking, counter-cyclical adjustment does exist in financial supervision. Supervision has become an important part of macroeconomic regulation and control in China. In the financial de-leveraging process between 2016-2017, numerous business was suspended overnight, which is quite bizarre. In addition, for the trust loans and entrusted loans in the social financing, the relevant policies should be milder under the context of the current economic counter-cyclical regulations.
In many cases, the ideas and directions of policy makers are correct, but it could easily cause market resonance under the system. In addition, considering the current global economic downturn and central banks' interest rate cuts, China should maintain part of the countercyclical regulations, especially in the fund supply.
I do not agree that real estate can be used as a means of stimulating the economy, while I do not think real estate can be a means of suppressing the economy as well. In terms of real estate, the regulatory policy is even tightener than the counter-cyclical control policy, which is debatable. To stop the funds from flowing to the real estate market, whether we should start with the supply side or the demand side of the real estate requires a more delicate screening process.
So far, shadow banking is still a very vague concept. For the development of shadow banking, I believe that we could "block" and "dredge" it at the same time. For the time being, we should realize a bigger scale of the shadow banking on the basis of further standardizing it, rather than simply keeping the stock of shadow lendings stable.
Objectively speaking, maintaining a stable shadow lending stock means a zero growth rate year-on-year. From this perspective, I believe its growth rate should be kept at least at an appropriate proportion to China's economic growth. While keeping up the supervision, we should also vest more positive energy in the shadow banking. The industry has demonized it enough. We should seek to "dredge" the shadow banking instead of "blocking" it, especially in the key areas.
