Professional Interpretation

1. What is the Shadow Banking

Scholars and professionals in the world have set different concepts for shadow banking. Most scholars call it a shadow banking system or the "near-bank" system, the “parallel-banking” system, “parallel system". Although the terms are different, most of them define the concept from scope and risk of the shadow banking system in the reality. According to the definition of Financial Stability Board (FSB), the so-called "shadow banking" refers to the credit intermediary system that flee outside the banking supervision system and from which systematic risk and regulatory arbitrage most probably arise (including related Institutional and operational activities).

At present, there is no formal legal definition of "shadow banking" in our country. In 2013, the General Office of the State Council once described the shadow banking in the "Circular on Strengthening the Supervision of the Shadow Banking" as follows: "Some credit intermediaries other than the traditional banking system Institutions and businesses (hereinafter referred to as "shadow banking") ... China's shadow banking mainly includes three types: first type is a totally unsupervised credit intermediary that does not hold a financial license, including a new type of internet finance company, a third-party financial institution, etc. second type is a credit intermediary institution that does not hold a financial license either and has insufficient supervision. These include financing guarantee companies, small loan companies, etc. Third type refers to some institutions that hold financial licenses but circumvent regulatory or are insufficiently regulated in business activities. It includes money market funds, Asset securitization, and some wealth management businesses. "In the international arena, shadow banking generally be considered to comprise non-bank financial institutions such as investment banks, hedge funds, money market funds, bonds, insurance companies and structured investment vehicles (SIVs). With the research goes further, although financial intermediaries other than banks remain the core of shadow banking, however, the extension of the shadow banking system is more and more broad and includes a series of shadow banking elements: investment banking, SPV, MMF, SIV, Hedge funds, asset management companies, private equity funds and other non-bank financial institutions as well as financial instruments such as ABS, CDO, CDS and ABCP Products, but in our country the main form of presentation is often not a certain type of organization, but in the form of enterprise products.

2. The Characteristics of Shadow Banking

Innovation

China's shadow banking first appeared in the financial crisis in 2008. In recent years, due to sufficient private capital and low rate of deposit interest of bank, wealth management products are not attractive enough to absorb all private capital. While there is a large amount of capital needs and financing difficulties for the small and medium-sized enterprises, innovative financing products spring up explosively as a result. Such as the electronic payment products Alipay led by online retail intermediary Taobao, a variety of asset securitization products due to growing demand driven by private capital, many forms of flexible net-funding, P2P, etc. which with financing capabilities but not a business model that traditional banks or financial institutions are engaged in. Many businesses rely on Internet tools which are highly efficient and have widespread disintermediation of their financial resources. A large number of products operate outside the system of administrative control and there is a lack of regulation. These forms of business provide financing, credit and liquidity conversion functions as a bank, but they do not have a business entity that bank has. Due to regulatory constraints, or because of the financial monopoly of traditional financial institutions, banks often cannot face customers directly and it is impossible for customers to obtain funds directly from banks. As a result, shadow banks have emerged as channels for financing.

Hidden

At present, most of the "shadow banking" in China are not independent organizations, they more reflect a property of avoiding regulation. Due to their innovative nature, many business forms are beyond the scope of the original supervision, without regulation and the fund flow secretly. Some institutions do not belong to the management of China Banking Regulatory Commission and the People's Bank, but its innovative derivatives tools are with the nature of bank such as financing guarantees, so supervision grey-gap arise. For example, "Bank Credit Cooperative" appeared in previous years, banks provide "hidden" loans to enterprises through the way of trust wealth management products. Take the real estate industry as an example to explain  the operation mode: if a real estate developers lack of funds for the development of real estate projects, banks cannot directly loan to developer due to regulatory reasons, then bank turned to trust companies, through which the real estate to be developed are mortgaged to bank, then the financial products based on the cash flow of the project are designed and consign the bank to sell to investors, at last the real estate developers obtain the project funds and pay the bank custodian fees when the project has been developed and sold, trust companies charge service fees as well as investor income. This example demonstrates banks can issue loans not out of deposits but through the issuance of trust wealth management products.

There are many business strategies and modes of implementation taken by Alibaba are not in line with the existing financial system framework. Such as Alipay can set a higher interest rate than the bank's financial products in the initial stage, of course it is more attractive to capital flow than financial products of bank, but neither it under the supervision of banks nor is the object of ordinary financial policy, so supervision of it becomes a headache for the financial authorities.

What needs to be clear is that Annual Report released by China Banking Regulatory Commission in 2012 clearly defines the scope of shadow banking for the first time: "The six types of non-bank financial institutions supervised by China Banking Regulatory Commission and their businesses and the off-balance sheet activities of commercial banks do not belong to shadow banking."

Complexity

On one hand, the forms of shadow banking product include not only some traditional financial products like bank-credit, bank-bonds products that traditional banking institutions have, but also some non-bank institutions such as Microfinance companies, P2P product lines, crowd-funding, asset-backed securities, guaranteed debt instruments, credit default swaps, asset-backed commercial paper and other financial instruments and products. On the other hand, the fund circulation structure of shadow banking often involves many financial institutions and private capital. The capital source presents complex diversity and the flow of funds is implicated.

Risky

The shadow banking may lead to systemic risks, the trigger factors include: maturity mismatch, liquidity conversion, credit conversion and high leverage. We believe the liquidity risk, credit risk and contagious risk should draw regulators and investors' attention. On one hand, the liquidity risk of shadow banking is very high due to the mismatch of term, poor stability of cash flow and weak supervision of funds, Meanwhile, once the shadow banking product development momentum is good, investors may have doubt in their confidence to traditional financial institutions and their ability, if the shadow bank broke its capital chain, it may affect market confidence even weaken the credit ability of the state financial institutions and product agencies; Third, the shadow banking and the traditional banks are strongly interactive and the former is more secretive with very complicated structure. Therefore, it is contagious especially under the condition of tight liquidity. The shadow banking which mainly serves SMEs will face a higher credit risk, the operating system is very likely to have a breakdown in the funding chain thus triggering financial systemic risk.

3. The Legislative Supervision and Advice

For a long time, between the main body to participate implementation of the shadow banking business and the regulatory authorities, it was like a game between cat and mouse for business innovation and regulatory gaming. In the initial stage of gaming from 2008 to 2010, bank cooperated with credit and the shadow banking sector started to take shape. During the period from 2011 to 2013, due to regulatory restrictions on the cooperation channel between Bank and Credit, the single cooperation model convert to multi-way of cooperation between bank-bank, bank-security. The third phase of 2014-2017: Bank- Credit, Bank-Securities are all subject to regulatory policies, then bank-fund relayed race, business between bank-bank varied, arbitrage chain under multi-channel mode has elongated, shadow banks continue to soar. From the perspective of arbitrage regulatory, banks seek to cooperate with the channels at each stage that have the least regulatory power to raise funds through wealth management products or inter-bank liabilities (including interbank certificates of deposit), and transfer the credit assets out of the table with the help of channel, resulting in the explosive expansion of relevant channel and institutions.

Due to the constraints of the domestic financial system and the environment, many shadow banking operations in China mainly depend on physical banks and become the shadow of banks. Domestic shadow banking funds mainly come from the bank's off-balance-sheet wealth management products and bank (inter-bank) liabilities. The funds mainly flow to the real economy such as real estate, local government financing platform, high pollution industry, high energy-consumption industry, overcapacity industries and short-funded SMEs and stocks, bonds, non-standardized creditor’s rights and other assets. Since 2015, with the drop of return on real economy, many shadow bank funds flow to real estate or remain in the financial system by adding leverage, maturity mismatch, and credit subsidence to arbitrage, forming the arbitrage chain of "interbank deposit – wealth management – exterior investment ".

Well, in the light of its causes, we can try to take the following ways for shadow banking to regulate its legislation breakthrough

A. Adjusting the Financial Leverage Policy Package

As many shadow banking have a credit crunch on every level of funds, there is leverage for each level and high leverage has also become an important factor in triggering a systemic crisis. The policy package for lowering financial leverage in the future should shift from the original "tight currency + strict supervision and weak reform" to the mode of "wide money + strict supervision and strong reform". For example, the United States in the financial de-leveraging monetary policy and regulatory policies. In the 2009-2014 period, the Federal Reserve has been implementing zero interest rates and the quantitative easing, but upgraded the regulation of real estate and commercial banks, Volcker's law has been implemented and the leverage ratio controlled  to achieve financial de-leverage. The real estate financial bubble was not over-inflated. The private-sector balance sheet was restored and the economy stepped into a sustainable recovery track. In the match reform of financial and substantive, it is expected that shadow banking will be shifted to new business areas such as asset securitization through prudential supervision and regulation. Shadow Bank can be guided to revitalize its existing credit facilities through standardized and professional asset securitization services, thereby further enhancing the efficiency of financial intermediation and bringing new vitality to the real economy.

B. The Direction of Legislative Policy should Lead fund Withdraw from fiction to the Virtual, Serving the Real Economy

In addition to the basic needs of risk prevention in the supervision of shadow banking, in making legislative policies it should also guide shadow banking to fully play the function of serving the real economy. Pushing forward the capital to serve real economy through the legislative and policy links, we can better realize the financial leverage and lead the funds to virtual and help control the disorderly expansion of shadow banking. At present, the under-leveraged financial assets are mainly real estate and local financing platforms. Low-efficiency sectors such as state-owned enterprises and local financing platforms take up too much resources with implicit endorsements and rigid delivery plus leverage, while annual input in high-efficiency business such as private enterprises, manufacture industry and producer service get reduced year by year, therefore, alongside the consolidation of the financial order, it is imperative to comprehensively promote the reform of financial & tax policies and systems in the relevant fields of state-owned enterprises and so on.

C. Unified Regulatory Standards, eliminate Arbitrage Space, to Curb the Channel Business

In the regulation of the shadow banking it should also focus on uniform regulatory standards and the uniform leverage of similar products to curb and eliminate arbitrage space; to break the rigidity of local financial exchanges and establish an equal access to capital management policies to eliminate multi-nested rent-seeking space; to curb the channel business, and strive to implement such strategies as penetrating supervision to achieve the shadow banking supervision.

Conclusion

The People's Bank of China once pointed out that for the problems and potential risks in the development of shadow banking, it is necessary to rationally define the scope and intensity of supervision, strengthen monitoring and statistics, continue to deepen financial reforms such as market-oriented interest rate, build a differentiated and multi-level financial system, prevent regional and systemic financial risks. As a credit intermediary system, shadow banking is an important link in realizing the direct financial conversion between the debit and credit in the market. How to better utilize the advantages of the shadow banking and minimize the risk of the shadow banking will become one of the most valuable legislation supervision topics, but also one of the new areas of legal value to be explored,