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Informal Finance in China: Risks, Potential and Transformation

Background

China’s rapid economic growth in recent decades has been attributed to its reliance on informal contracting and trust-based relationships (guanxi). This claims builds on the absence in China of some of the more formal legal and regulatory institutions of the market economies of the global north.  Although the claim that China lacks formal legal mechanisms of market governance may have been somewhat  overstated, it is the case that informal finance, particularly in the form of trade credit,  family lending and communal investing, has played a major role in supporting China’s growth. The prevalence of informal finance presents a significance source of flexibility for China’s economy given the limitations of the formal sector, which remains dominated by state-owned banks lending largly to state-owned enterprises.  Informal finance is also evolving quickly and is converging with the use of internet technologies to deliver finance (‘fintech’) through such mechanisms as crowdsourcing.  

However, there are downsides to the reliance of the Chinese economy on informal finance and significant risks arise from its convergence with fintech. The large shadow banking sector, by virtue of its positioning outside most of the regulations applying to mainstream banks, adds to systemic risks.  The formal and informal sector coexist in an uneasy relationship: they may substitute for each other, or provide complementary modes of finance, but they can also operate to reinforce and magnify systemic risks.

Similarly, the rise of fintech is a double edged sword.  On the one hand, cloud computing and big data may be facilitating new forms of social credit and collective investment schemes which have the potential to meet the needs of the growing social credit sector.  Crowdsourcing may provide a new and flexible form of financing for start-ups and innovative ventures. However, these new forms of finance also have the potential to undercut or render otiose regulations designed to maintain market transparency, and to intensify the risks facing investors.  

Aims & objectives

This an interdisciplinary research project exploring informal finance in China, the risks it is generating, its potential to support economic growth, and its transformation in the light of new technologies and a developing regulatory agenda. The work is being carried out by the CBR in collaboration with the School of Law, University of Sheffield, the School of Law, Renmin University, Beijing, and the College of Finance and Statistics, Hunan University. The project has the following aims:

  • To understand the potential, but also the limits, of systems of informal financing in China
  • To analyse the relationship between formal and informal finance in China
  • To examine the risks posed by China’s shadow banking system
  • To study the emergence in China of new forms of financing using big data and cloud computing to drive financial innovation, including P2P lending, crowd funding and similar collective investment schemes 
  • To explore the scope for the development of social credit systems in China.

Method

Part of the work involves fieldwork and surveys with internet financing companies and supervisory bodies in order to better understand the operation of the sector at both national and regional levels. We are also using law and economics analysis to build conceptual models of the likely options for regulation of internet finance and fintech-informed universal banking. A comparative legal study is being undertaken to assess the current state of law and regulation in China and the UK on these issues. In addition we are using questionnaires, face to face interviews and archival/documentary research to build up a picture of the current state of the shadow banking sector and its supervision, related aspects of informal finance, and the operation of social credit systems in China.

Results & dissemination

The work began in February 2017 and is currently ongoing.  An initial round of interviews was carried out in China in April 2017. On 15-16 April 2017 a conference on Fintech was held in Hangzhou, Zhejiang Province, organized with our Chinese research partners, and with the participation of industry-level actors, policy makers and regulators. In July 2016 the Cambridge team convened meetings with each of the Chinese teams and UK financial regulators based at the Financial Conduct Authority and Bank of England (Prudential Regulation Authority).

Journal articles

Stephen, F.H (2017), ‘The institutional environment required to support, China’s new normal economy’, China-EU Law Journal, 5:119–134 (DOI 10.1007/s12689-016-0071-x)

Book chapters

Stephen, F.H (2017), ‘New Institutional Economics, Culture and Corporate Governance’ pp. 45-60 in Franklin, N.N, Onyeka, K.O and Stephen, F.H (eds) Corporate Governance in Developing and Emerging Markets, London: Routledge.

Books

Ngwu, F.N, Onyeka K.O and Stephen, F.H (eds) (2017), Corporate Governance in Developing and Emerging Markets, London: Routledge.

Stephen, F.H (forthcoming January 2018), Law and Development: an Institutional Critique, Edward Elgar Publishing.

Conference/Workshop papers

Deakin, S. (2017) ‘Law, trust and institutional change in China’, paper presented to the Conference on Fintech in China, Hangzhou, 16 April 2017.

Stephen, F. (2017) ‘Law and development: an institutional critique’, paper presented to the Conference on Fintech in China, Hangzhou, 16 April 2017.

Project leaders

Simon Deakin (CBR)
Boya Wang (CBR)
Ding Chen (University of Sheffield)
Andrew Johnston (University of Sheffield)
Navajoti  Samanta (University of Sheffield)
Frank Stephen (University of Manchester)

Project status

Ongoing

Project dates

2017-2018

Funding

ESRC Newton Fund and National Science Foundation of China