Thanks to it, financial instruments with 17.5 trillion yuan of outstanding loans are unregulated. Thanks to it, small firms in China pay interest rates as high as 20-24%. Yet, the system of shadow banking in China is thriving. For the uninitiated, these are entities not regulated by the Chinese central bank. They do issue loans and hold deposits. But their loans and investments are often less liquid and riskier than their deposits purport to be. Importantly, in the absence of a regulator, players in this business can be predatory.

Unlike India, China imposes a ceiling on interest rate for bank deposits. Thus, as per an article in Economist, the Chinese shadow-banking system has evolved to merely help banks evade deposit ceilings. Also lack of access to credit forces small firms in China to borrow from the shadow banking system at astronomical rates. Now that is a malaise even India cannot claim to be free of. Until recently micro finance lenders in India lent to the poor at unreasonably high rates. Money lenders still thrive in Indian villages that do not have access to bank credit.

Thus, whether in India or China, the system of shadow banking will thrive until there is financial inclusion. Also financial policy making must be more liberal and transparent.