The Real Effects of Shadow Banking: Evidence from China

We provide firm-level evidence on the real effects of shadow banking in terms of technological innovation. Firm-to-firm entrusted loans, 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, information asymmetry, and takeover exposures. A plausible underlying channel is capital reallocations from less productive but easily financed lender firms to more innovative but financially less privileged borrower firms. Our paper suggests that shadow banking helps correct bank credit misallocations and thus, serves as a second-best market design in financing the real economy. This paper was accepted by Kay Giesecke, finance. Funding: X. Tian and Y. Wang acknowledge financial support from the National Natural Science Foundation of China [Grant 71825002] and the Beijing Outstanding Young Scientist Program [Grant BJJWZYJH012019100003014]. G. Tu acknowledges financial support from the National Natural Science Foundation of China [Grant 72010107001]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00953 .