Shadow Banking and Commercial Bank Profitability: Evidence from China

Abstract

In recent years, China has witnessed a growing investment demand from the household sector. However, financing gaps persist in industries subject to macroeconomic regulation and among small and medium-sized private enterprises. These gaps, alongside regulatory arbitrage by commercial banks, have fostered the emergence and gradual expansion of shadow banking, which has become an integral part of the financial system. While shadow banking enhances resource allocation efficiency, eases financing constraints, and boosts the profitability of commercial banks, its high leverage and maturity mismatch may also undermine the stability of bank revenues. This paper reviews the theoretical foundations of shadow banking both domestically and internationally, clarifies its definition, explores its drivers and development, and investigates its relationship with commercial bank profitability. Employing empirical analysis, the study examines the correlation between the size of shadow banking and key profitability indicators in China’s banking sector. Based on these findings and the current national context, the paper offers policy recommendations to help shadow banking institutions and commercial banks better recognize and address potential risks and challenges in their development.