Jobs and economic expansion are key goals for China’s policymakers. But capital acquisition by firms can be difficult and lead them to shadow banking which may cause serious economic and financial consequences.

China must expand its macroeconomy to provide jobs, keep factories operating, and stay globally competitive. The problem is that many Chinese firms either cannot operate in an efficient and profitable manner or lack financial resources to grow or remain solvent.

For these firms, financial capital is severely needed, but fund acquisition is the conundrum. While shadow banking can help these businesses, new problems arise making for an even bigger dilemma.

What is shadow banking?

Shadow banking involves acquiring financial capital in an unregulated environment. This involves non-bank financial intermediaries providing firms loans, which is similar to traditional commercial banking but is actually outside the government’s regulatory purview.

For example, a clothing manufacturer lends money to an electronics maker without worry of financial regulations regarding collateral or meeting ratio requirements.

Small businesses in China can turn to shadow banking for loans when they are in a credit crunch, have exhausted the usual traditional forms of borrowing, or wish to avoid borrowing complications and expenses.

On the positive side, shadow banking allows quicker access to financial capital than traditional banking transactions.

This also means greater risk to the lender if the borrower has serious financial problems and needs funds to stay afloat while really masking widening financial cracks.

The scale of this issue in China is reflected in Moody’s estimates of China’s shadow banking industry which stand at $8.5 trillion.

Chinese businesses see shadow banking as a necessary alternative since they are faced with government imposed lending restrictions. These include limits on bank lending imposed by the People’s Bank of China (PBOC), a cap of bank loans to deposits of 75 percent, and government regulators discouraging loans to certain industries.

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