The Real Effects of Shadow Banking : Evidence from China

We investigate the real effects of shadow banking in the case of technological innovation. Using manually collected entrusted loan data, we find that firm-to-firm entrusted loans, once the largest part of the shadow banking sector in China, enhance the borrowers’ innovation output. The effects are more prominent when the borrowers are subject to severer financial constraints and information asymmetry. A plausible underlying economic channel is capital reallocations from less productive but easy-financed lender firms to more innovative but financially less-privileged borrower firms. Our paper sheds new light on the bright side of shadow banking in China, i.e., it helps correct bank credit misallocations and thus serves as a second-best market design in financing the real economy