Disadvantages Of Shadow Banking

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Shadow banking is a risky business. In China, there is a variety of shadow banking products. WMPs are the major funding sources.
The system is more volatile caused by the complicated mechanisms of shadow bank. By looking at the complicated shadow credit risk, first start with the wealth management products (WMPs). It is an alternative account to saving accounts with high interest rate. The reason of the higher rates for WMPs is because of the risk bank loans. These loans do not hold by banks on their balance sheets, instead these investment products (WMPs) are created by trust companies. For a company or individual that receives loans, they might spend part of the money directly and deposit the rest in a bank or WMPs. However, save in a bank,
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Just as Liao Min said: “China shadow banking is a broad concern, has liquidity mismatches, non-transparent asset and the fact that the end-users of such finance are often in the riskier sectors of the economy such as real estate and those struggling with over-capacity.” The non-transparent investments might increase the risk exposure and nowadays, Chinese shadow banking is more complicated and less regulated, which could make regional financial instability. For even worse situation, this may cause financial crisis in the future.

As mentioned before, RRR in China is 20%. A higher RRR will increase the size of funding in shadow banking system, which will tighten the liquidity in banks. Meanwhile, it leads to repo rate being higher. With a high repo rate, the financial costs on WMPs will increase,which will also enhance the default risk. At the same time, it pushed a mortgage rate that cuts down the real estate speculative investments and causes a reduction in housing prices. Currently, Chinese housing market has a great increase with new investments. There are large amount for development of real estate that are funded by WMPs. If the house prices become weaken, the return would be lower and default risk of loan repayments will enhance. Nowadays; in China, the house price are rising at a significantly rate, but the developers are more concentrated in having more investment, and not consider the residual house demand. Once in the future the price is over high and there is less demand. As more developers borrow from shadow bank, the default risk will increase and China will face a financial crisis and housing

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