The Nexus of Monetary Policy and Shadow Banking in China

Abstract: We study how monetary policy in China influences banks' shadow banking activities. We develop and estimate the endogenously switching monetary policy rule that is based on institutional facts and at the same time tractable in the spirit of Taylor (1993). This development, along with two newly constructed micro banking datasets, enables us to establish the following empirical evidence. Contractionary monetary policy during 2009-2015 caused shadow banking loans to rise rapidly, offsetting the expected decline of traditional bank loans and hampering the effectiveness of monetary policy on total bank credit. We advance a theoretical explanation of our empirical findings.