Does Economic Policy Uncertainty Affect the Development of Shadow Banking?

This paper explores the impact of economic policy uncertainty on the size of shadow banking using dynamic panel techniques based on unbalanced panel data for 170 Chinese banks from 2007-2019. The empirical results show that: (1) Economic policy uncertainty significantly increases the scale of shadow banking, and this finding holds after accounting for potential endogeneity problems and a series of robustness tests; (2) Heterogeneity tests find that small and medium-sized, low-capitalization and non-state banks have greater incentives to develop shadow banking in an environment of economic policy uncertainty compared to large-scale, high-capitalization and state-owned banks; (3) Mechanism tests show that economic policy uncertainty significantly increases the scale of shadow banking mainly in three ways: increasing business risks for banks, tightening restrictions on corporate financing, and decreasing bank profitability; (4) Macroeconomic prosperity reduces the positive impact of economic policy uncertainty on shadow banking, while government intervention increases the positive impact of economic policy uncertainty on shadow banking; (5) Regional heterogeneity tests find that banks in the central and western regions have greater incentives to develop shadow banking in an environment of economic policy uncertainty compared to the eastern regions of China