Wealth Management Products And Regulatory Arbitrage: Evidence From China’s Shadow Banking System

China’s Shadow banking has been evolving and expanding rapidly,with banks actively using wealth management products(WMPs)to circumvent regulatory restrictions.These products are the largest and most important constituent of China’s shadow banking sector.A large number of these products are off-balance-sheet and considered a substitute for bank deposits.Commercial banks in China are involved in the issuance of WMPs mainly to evade the regulatory restrictions,move toxic assets away from the balance sheet,chase the profits,and take advantage of lower deposit rates.In order to control and maintain the liquidity and credit risks in terms of existing regulations,the regulatory authorities try to achieve strict regulations for the banking industry.This type of stringent strategy helps regulators limit the banking sector to disclose the specific data,keep the reserves,and maintain various banking ratios.Banks often restructure their financial activities in order to reduce regulatory costs,circumvent regulatory restrictions,improve profitability and liquidity.By involving in shadow or off-balance-sheet activities,banks can easily evade the existing regulations and create alternate channels to transfer the liquidity and credit risks.In a banking system,the banking regulations’ ultimate objectives are to;maintain stability,control the liquidity levels,avoid systemic risk,and supervise the required financial ratios.When banks are involved in less regulated and complicated shadow activities,regulatory authorities’ interventions are subverted,which likely yield systemic risk and the potential threat to financial stability.In the context of China’s shadow banking,primarily commercial banks are the leading contributors to these shadow activities.This study is motivated to step ahead to investigate what bank-related characteristics and needs influenced and prompted the issuance of these products and how banks take advantage of the regulatory arbitrage by issuing WMPs.The small and medium-sized banks(SMBs)confronted a sustainability risk in the deposit market due to the stimulus package in the 2007-2008 global financial crisis(GFC)and statutory ceiling on the bank deposit rate.As a result,the SMBs utilized these products to evade regulatory restrictions and sustainability risks in the deposit market.This research empirically examined how Chinese banks,specifically SMBs,use these products on a long and short-run basis to manage and control their deposit levels.Banks issued more WMPs to control and manage a 75% statutory ceiling on the loan-to-deposit ratio(LDR)in the pre-2015 period.This WMP-LDR positive association disappeared post-2015 period.This study also investigated that how banks utilize WMPs to avoid regulatory constraints.Moreover,how commercial banks,specifically SMBs,exploit WMPs to offer higher yields on new products.This research employed a compressive set of quarterly data ranging from 2010 to 2019 for the top 30 banks of China.These banks comprise 70% of China’s total banking assets,and they are also the leading issuers of WMPs.The implementation of rigorous and robust static and dynamic panel models;and comprehensive robustness checks make this research more reliable.The estimated results revealed that banks issue WMPs for the multi-purpose and off-balance-sheet status of these products makes them very lucrative for regulated banks.The findings further approve the existence of a stable long-run substitute relationship between deposits and WMPs.This research also evidenced that China’s banking sector depends on WMPs to manage and control critical regulatory ratios.Furthermore,the issuance of WMPs has a positive and significant impact on the yields of new products.This research’s outcomes contribute to the growing literature on shadow banking in China by providing an in-depth empirical analysis of WMPs.