The Risk of Implicit Guarantees: Evidence from Shadow Banks in China

Abstract

Abstract We study how risks spill over from shadow banking activities to traditional banks through implicit guarantees. Using data on wealth management products (WMPs), China’s largest shadow banking component, we find that banks with higher interbank borrowing rates strategically provide stronger implicit guarantees to their issued WMPs. Extending implicit guarantees builds bank reputations and reduces rollover costs while exposing banks to losses from shadow banking activities. Our findings thus suggest a bank-specific approach to assessing the risk of implicit guarantees based on transparent and real-time interbank rates.