China has two strategies that can operate together to deal with shadow banking, said Iain Gerard MacNeil, dean of the Law School of the University of Glasgow.
According to him, to cope with shadow banking, China can either cut out the activities that are outside the regulated areas or else expand them.
MacNeil has been a member of the International Securities Regulation Committee of the International Law Association (ILA) since 2006 and was an invited participant by the Bank of England Annual Seminars on Financial Regulation between 2013 and 2017. He is also a professor doing research on financial regulations. This year, he wrote a book called Research Handbook on Shadow Banking, which involves contents about China.
"The scale of shadow banking in China has grown to be bigger than any other countries with various mechanisms that are used to engage in shadow banking activities. So, China needs to have some stricter controls on it," said MacNeil.
However, he also mentioned that to eliminate shadow banking is not a good idea as well because there may be beneficial activities that are taking place in the shadow banking marketplace.
"This is linked with innovation because if you solely eliminate shadow banking, you will have some effects on shadow banking as well. If you curb it very suddenly, you will have a substantial effect on the supply of credit. It will be a shock to the economy," said MacNeil.
From his perspective, to adopt the two ways together could help China soften the effect brought about by the regulations on shadow banking.
"China can do both by expanding the activities that are within the regulatory perimeter, or you might say the formal activities, it can allow them to expand to encompass some of the activities that are taking place in shadow banking. Then for some of the more dangerous elements of shadow banking, you can eliminate them," said MacNeil.
Will the regulations on shadow banking hurt small and micro businesses?
MacNeil holds that it shouldn't be too damaging for entrepreneurship in the long run.
"One of the responses to curb the shadow banking would be to have the same activities channelled through regulated institutions. Whether it turns out that there will be a reduction in the overall supply of credit is more difficult to work out, for example, if the same activities move into the regulated sector, and the supplied credit continues, then it shouldn't be too damaging for entrepreneurship," explained MacNeil.
China has been striving to prevent financial risks, which includes the regulations on shadow banking.
According to his book, Research Handbook on Shadow Banking, we can identify shadow banking from its ability to fund long-term commitments through short-term liabilities.
For financial stability, the regulation of shadow banking should focus on entities and transactions allowing liabilities to be accepted as a substitute for money, as put in the book.