Shadow Deposits as a Source of Financial Instability: Lessons from the American Experience for China

Nicholas Borst (Federal Reserve Bank of San Francisco)
Policy Brief
13-14
May 2013

In less than a decade, China has developed a shadow deposit system similar in scope and function to money market mutual funds in the United States. Wealth management products in China have emerged as an important source of short-term financing for the Chinese economy and are likely to continue to grow in coming years. These products promise savers higher interest rates than the controlled rates on traditional bank deposits but offer fewer investor protections. As such, these financing pools are vulnerable to rapid retrenchment when financial difficulty forces investors to reevaluate the risk of these investments. Consequently, a source of potential financial instability has been created in the Chinese economy. US experience in regulating shadow deposits offers useful lessons for China to guide its own financial development in a healthier direction.