This thesis studies the unintended consequences of the liquidity regulations imposed on Chinese banks. Nonstate banks conduct regulatory arbitrage to bypass the liquidity regulations and shift their business towards shadow banking, evident in the sharp increase of account-receivable investments. This paper evaluates the risks embedded in the shadow banking transactions conducted by banks using a comprehensive dataset on entrusted loans. Entrusted loans facilitated by nonstate banks are riskier and default more often than those facilitated by state banks. As a result of the risk-taking motive and additional costs of such transactions, banks lack incentives to monitor the entrusted loan borrowers. Lower monitoring of banks results in negative consequences for the borrowing firms, a...[ Read more ]

This thesis studies the unintended consequences of the liquidity regulations imposed on Chinese banks. Nonstate banks conduct regulatory arbitrage to bypass the liquidity regulations and shift their business towards shadow banking, evident in the sharp increase of account-receivable investments. This paper evaluates the risks embedded in the shadow banking transactions conducted by banks using a comprehensive dataset on entrusted loans. Entrusted loans facilitated by nonstate banks are riskier and default more often than those facilitated by state banks. As a result of the risk-taking motive and additional costs of such transactions, banks lack incentives to monitor the entrusted loan borrowers. Lower monitoring of banks results in negative consequences for the borrowing firms, as these firms conduct more diversifying acquisitions and encounter more lawsuits and misconduct, compared to firms that only borrow bank loans. These findings suggest that the risk taking of banks adds to risks in the real sector through lax bank monitoring.