Chinese shadow banking totals only about 2.2 trillion.

In 2007, the volume of shadow banking transactions in the US exceeded that of conventional banking assets.

Meanwhile, China s shadow banking system has expanded at an unprecedented rate.

Perhaps the biggest risks stem from China s rapidly growing shadow banking system.

But just how extensive and how risky is shadow banking in China?

Since 2008, shadow banking has exploded, owing to price and regulatory factors.

Now, growth in shadow banking activities has been added to the list.

Oblivious to the role of the shadow banking system, the Fed did not understand how its implosion would undermine the traditional banking system.

The shadow banking sector s dependence on the official banking sector s liquidity and guarantees, and thus ultimately on the government, has not even been touched.

Where, then, will the high returns of the financial products provided by the shadow banking system come from?

In fact, the existing shadow banking risks are manageable, given relatively robust GDP growth and strong macroeconomic fundamentals.

Chinese policymakers should view the shadow banking scare as a market driven opportunity to transform the banking system into an efficient, balanced, inclusive, and productive engine of growth.

But momentum is flagging, both on implementing the agreed reforms and on progress in areas like derivatives and shadow banking.

Shadow banking in China is dominated by lending to higher risk borrowers, such as local governments, property developers, and SMEs.

Ultimately, addressing shadow banking in China will require mechanisms that clearly define, allocate, and adjudicate financial risks among the key players.

HONG KONG The proliferation of China s opaque, loosely regulated (or unregulated) shadow banking system has been raising fears of possible financial instability.

With relatively slow growth, corporate profitability, upon which the returns of the shadow banking system s asset pools are based, is low and falling.

Indeed, the Fed regulates only banks, so liquidity and leverage will migrate to the shadow banking system if banks are regulated more tightly.

China s financial stability is also under threat, as lenders turn to unofficial channels to circumvent tighter government regulations on the formal banking system. Perhaps the biggest risks stem from China s rapidly growing shadow banking system.

The investment loans and massive debts among local financing platforms, together with the off record credit channeled through the shadow banking system, are increasing the risk that non performing loans will soon shake the banking sector.

Until the financial reforms adopted since the crisis, this shadow banking system operated outside the regulatory regime that applied to traditional deposit taking banks.

Indeed, shadow banking would not have grown so fast had that regime not been devised with the apparent lessons of the 1930 s in mind.

At the very least, the combination of higher interest rates in the shadow banking sector and weaker nominal GDP growth undermines borrowers debt repayment capacity.

Thus, the real issue in China is not the volume of shadow credit, but its quality, and the banking system s capacity to absorb potential losses.

The introduction of measures to cool the property market, and new direct regulatory controls over shadow banking credit, represent a step in the right direction.

Securitization (and shadow banking) will be kept simple and proceed at a measured pace as a new legal and regulatory framework is built and tested.

Ultimately, however, the measures should enable China s shadow banking system to continue to grow at a more manageable pace and in a more sustainable way.

That would have preserved the functioning of the system while severely punishing the banking and shadow banking systems equity holders, and today nobody would be claiming that their risk management practices were adequate and did not need reform.

According to the China Banking Regulatory Commission, shadow banking (all credit not regulated by the same standards as conventional bank loans) increased from 800 billion ( 130 billion) in 2008 to 7.6 trillion in 2012 (roughly 14.6 of GDP).

However, Basel 3 only indirectly addresses the shadow banking system, despite its role in triggering the crisis and the future threats it poses for financial stability.

Thus, Chinese policymakers must focus on curbing the shadow banking sector s growth, while ensuring that all current and future risks stemming from the system are laid bare.

China s vulnerabilities and risks stemming from property bubbles, shadow banking, and local government debt have triggered concerns about a crisis not only there, but also in neighboring Asian countries.

Most of the shadow banking system has disappeared, and traditional commercial banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalized.

In a worst case scenario, falling property prices or diminishing faith in implicit government guarantees would compound the risks generated by the shadow banking system, severely undermining China s financial stability.

Loosening monetary policy would increase significantly the risks stemming from local government debt and shadow banking, while tightening monetary policy would fully expose those risks, posing a serious systemic threat.

the decision was made to eschew principles based regulation and allow the shadow banking sector to grow with respect to its leverage and its compensation schemes, in the belief that the government s guarantee of the commercial banking system was enough to keep us out of trouble

According to market sources, total assets managed by the shadow banking system have risen exponentially since 2009, totaling 14 trillion, or one third of GDP, in the third quarter of 2012.

There is good reason to believe that China s new leaders are now determined to wean the economy off ever mounting (and destabilizing) debt especially in its rapidly expanding shadow banking system.

Shadow saturation

And the regulatory boundary problem persists risky activities may migrate to areas where regulation is lax and reproduce the problems with the shadow banking system that we have witnessed during the crisis.

In 2013, the talk has changed to the danger of a resurgent housing bubble and the collapse of the shadow banking system, which consists mainly of wealth management firms and trust companies.

The Fed simply failed to comprehend the significance of traditional banks large holdings of mark to market assets and their own engagement in shadow banking via off balance sheet structured investment vehicles.

And the regulatory boundary problem persists risky activities may migrate to areas where regulation is lax and reproduce the problems with the shadow banking system that we have witnessed during the crisis.

The mouse's shadow at dusk is longer than the cat's shadow at noon.

Other terms include parallel banking, underground banking and ethnic banking.