Shadow Banking, Essay Example

A recent development in the financing sector, in countries such as China, is what is known as shadow banking, which gives businesses an alternative to seeking capital loans from conventional banks. Businesses that previously had trouble obtaining credit from banks are now being funded through crowdfunding efforts from sources such as individuals, leasing companies, money-market funds, and trusts via shadow banking (Jiang). One way borrowers in China are taking advantage of the opportunity that shadow banking brings is to borrow money for mortgage loan down payments, which are about 30 percent of the sale price of the property. Shadow banking loans often offer home buyers very low or no interest for a year and it is easier for people to qualify for them. Investors who chip in to fund these loans earn about 8 percent, which is higher than what they would earn from investments from traditional financial institutions. Bloomberg reported that down payment shadow loans in China were projected to possibly reach 20 billion yuan in 2014 and 1.2 trillion yuan in 2015 (Bloomberg).

Because shadow banking offers credit to borrowers who may not otherwise qualify for loans, it has a certain level of risk associated with it. Particularly because shadow banking activities are not regulated by the usual financial regulatory institutions. However, despite the perceived risk, this concept has caught on well in China, as about one-third of the activity in the shadow banking sector worldwide had taken place in China, as of year-end 2013 (Reuters).

This paper answers two questions posed regarding the concept of shadow banking as follows.

Should we be concerned about shadow banking?

It is unlikely that individuals or businesses needing funding have much to fear regarding shadow banking. This is because these are the people and entities who benefit the most. It is often difficult, with S&P, Dun & Bradstreet, and credit scores, for companies and individuals with less than perfect credit to obtain funding to help them out of their financial situations. Additionally, when they do manage to qualify, their interest rates are extremely high, making it very difficult to pay back the loans. On the other side, many investors are frustrated with low investment returns offered by traditional investment options, so investing in the shadow banking sector means higher returns on investments. However, investors should also be cautious when lending in this area because borrowers may be more likely to default. So, investors may have reason for concern as well as the traditional banking sector, due to loss of business to shadow banking as a competitor.

Would you compare this shadow banking to something like PAYDAY LOANS in the US or something else?

Payday loans are not actually similar to shadow banking. With payday loans, borrowers authorize a personal check payable to the payday loan lender, including the loan fee based on the loan amount. The payday loan lender loans the borrower the money minus the fee and holds the check for two weeks, at which time the borrower must come back in to pay the amount borrowed and the fee. If the borrower is still in need of funds, a new check is written and the borrower “rewrites” for the same or a different amount and will be assessed a new fee. If the borrower fails to pay the amount borrowed plus the fee in two weeks, then the payday lender cashes the check against the borrower’s account. Payday loans have extremely high interest rates, often upwards of 400%, and they often get borrowers trapped, so they end up paying back much more than the original loan (FTC).

With shadow banking, borrowers are charged such high interest rates as with payday loans and they are offered better loan terms. Shadow banking is actually more similar to crowdfunded lending from peer-to-peer groups in the US, such as Prosper or Lending Club where loans are funded by a pool of individuals who receive returns on their investments to the loans to which they contribute. These individuals are attracted to the idea of higher yields on their investments than they can get from traditional investing in instruments such as certificates of deposits, savings accounts, and bonds (Berger).

Conclusion

The concept of shadow banking and its peer-to-peer concept is a means of making credit available on a global scale. Individuals and businesses in one country can have loan requests funded from other individuals and businesses from around the world, and it is all done online. This could possible result in traditional financial lending institutions changing the way they do business, as consumers may drive lending in another direction with the concept of peer lending. People are, no doubt, tired of being turned down for loans and investors want to earn more. Shadow banking is definitely an interesting concept that has come about in this age of technology and globalization.

Works Cited

Berger, Rob. An Investor’s Guide To Peer-To-Peer Lending. 6 November 2015. Web. 23 December 2015. <http://www.forbes.com/sites/robertberger/2015/11/06/an-investors-guide-to-peer-to-peer-lending/>.

Bloomberg. Going Online to Borrow Down Payments in China. 26 November 2014. Web. 23 December 2015. <http://www.bloomberg.com/bw/articles/2014-11-26/big-in-china-online-loans-for-mortgage-down-payments>.

FTC. Payday Loans. March 2008. Web. 23 December 2015. <http://www.consumer.ftc.gov/articles/0097-payday-loans>.

Jiang, Jing. Shadow banking in China: Battling the darkness. 10 May 2014. Web. 23 December 2015. <http://www.economist.com/news/finance-and-economics/21601872-every-time-regulators-curb-one-form-non-bank-lending-another-begins>.

Reuters. Property, manufacturing woes help trip China’s shadow banking. 25 November 2014. Web. 23 December 2015. <http://gulfnews.com/business/sectors/banking/property-manufacturing-woes-help-trim-china-s-shadow-banking-1.1417654>.