Shadow Banking, External Financing Dependence and the Performance of Smes : Evidence from China

China's attempts to reduce financial system risk through tighter shadow banking regulation may have had unexpected effects. Using the regulatory policy of the New Capital Management Regulation, this paper investigates the impact of tightening shadow banking size on SMEs' performance using an intensity difference-in-differences model. We show that the decline in the size of shadow banking considerably reduces enterprises investment with high external financing dependence. This negative effect is more pronounced among non-politically connected and high-tech firms. Our empirical evidence suggests that the increase in the cost of credit for enterprises could be the underlying channel of its impact. In addition, we find that regulatory policy reduces both SMEs' total factor productivity (TFP) and innovation output. These findings suggest that shadow banking is an essential financial resource for the development of SMEs, and that regulatory policies lacking accompanying measures may have been costly to the real economy