Shadow banking and loan pricing

We examine the role of regulatory arbitrage via wealth management products (WMPs) in the determination of lending rates in China. We find WMP yields are positively associated with lending rates whereas the effect of WMP scale varies across bank size. For the big-5 state-owned banks, the negative “transfer-effect” of high-risk high-yield loans into shadow bank credit dominates the positive “funding-cost-effect” of banks becoming more dependent on wholesale funding. For smaller banks, the positive funding-cost effect dominates. Our study provides insights into the role of regulatory arbitrage on asset structure and profit margins in the interest of banks and the regulators.