The Impacts of China's Shadow Banking Credit Creation on the Effectiveness of Monetary Policy

Abstract

This paper researches the impact that shadow banking in China has upon credit creation and the potential effectiveness of monetary policy. Using a credit creation model, we derive the effect that shadow banking has upon the money multiplier and the money supply. The model shows that shadow banking can change the money multiplier, potentially increasing it during an expansion and decreasing it during a contraction. Introducing shadow banking in a CC-LM model results in a shift of the CC and LM curves resulting in a higher equilibrium output. A vector autoregressive model is used to empirically estimate the impact of shadow banking deposits' growth rate on the growth rates of the broad money supply, GDP, and the CPI. The results show that shadow banking's credit creation function in China has a pro-cyclical characteristic, potentially reducing the money supply's controllability and increasing the difficulty in effectively regulating monetary policy. This paper introduces shadow banking into the currency creation process of traditional commercial banks, accounting for the reserve requirement ratio, the excess reserve ratio, the shadow bank leakage rate, and the reserved deduction rate. Future research can determine whether coordinating monetary policy and leverage ratio regulation mitigates the impact of shadow banking. Another area of research is how the shadow banking of non-financial companies affect monetary policy.

Keywords: {'name': 'Shadow banking, Credit creation, Monetary policy, CC-LM model, VAR model'}

Authors & affiliations

Huiyi Zhang
Affiliation not supplied

Richard Skolnik
Affiliation not supplied

Yu Han
Affiliation not supplied

Jinpei Wu
Affiliation not supplied

Deposited references

Supplied references, not a list of publications citing this article.

DOI: 10.1016/j.jfineco.2012.09.004

DOI: 10.1016/j.jfineco.2019.01.006

DOI: 10.1016/j.jimonfin.2012.05.027

DOI: 10.3386/w1054

Bernanke, B.S., & Gertler, M. (1989). Agency costs, net worth, and business fluctuations. American Economic Review, 79(1), 14-31.

DOI: 10.1016/j.jfineco.2018.03.011

DOI: 10.2139/ssrn.3140074

DOI: 10.1257/aer.20170133

DOI: 10.1016/j.jfineco.2016.07.003

DOI: 10.1016/j.jbankfin.2015.06.016

Elliott, D., Kroeber, A., & Qiao, Y. (2015). Shadow banking in China: A primer. The Brookings Institution: Economic studies.

DOI: 10.2139/ssrn.2467761

DOI: 10.1016/j.jet.2018.09.003

DOI: 10.2139/ssrn.2220822

DOI: 10.1057/9781137496133

Lian, F. (2018). Chinese-style shadow banking and money supply: promoting or repressing? Research from the perspective of credit creation. Wuhan Finance Monthly, 8, 24-29.

Ma, Y., & Duan, Q. (2018). The procyclicality of China's shadow bank and its monetary policy effect: An analysis based on the TVP-VAR Model. Modern Finance and Economics, (12): 146-157.

Mazelis, F. (2014). Monetary policy effects on financial intermediation via the regulated and the shadow banking system. SFB Discussion Paper, 20,182-190.

Mazelis, F. (2016). Implications of shadow bank regulation for monetary policy at the zero lower bound. SFB 649 Discussion Papers. No.SFB649DP2016-043, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

DOI: 10.2139/ssrn.2439886

Moody's. (2019). Quarterly China Shadow Banking Monitor. Moody's Investors Service, New York.

DOI: 10.1111/jofi.12540

DOI: 10.1002/jae.2594

DOI: 10.1093/rfs/hhu055

DOI: 10.2139/ssrn.1645337

Qiu, X., & Zhou, Q. (2014). Shadow banking and monetary policy transmission. Economic Research Journal, 5, 91-105. http://jtp.cnki.net/bilingual/detail/html/CMJJ201901007

Sun, G. (2019). China's shadow banking: Bank's shadow and traditional shadow banking. Bank for International Settlements Working Papers, 822: 1-43. https://www.bis.org/publ/work822.htm.

Valckx, N., Amidzic, G., Arregui, N., Blankenheim, J., Ehrentraud, J., Gray, D. & Sugimoto, N. (2014). Risk taking, liquidity, and shadow banking—curbing excess while promoting growth. International Monetary Fund Global Financial Stability Report, 10, 65-104.

Verona, F. (2011). Monetary policy shocks in a DSGE model with a shadow banking system, CEP-UP Working Paper, (01):19-33. https://econpapers.repec.org/RePEc:por:cetedp:1101.

Wang, Z., & Zeng, H. (2014). Theoretical and empirical analysis of the impact of shadow banking on monetary policy. Studies of International Finance, 12, 58-67.

DOI: 10.1016/j.iref.2018.09.004

DOI: 10.1016/j.pacfin.2019.06.016