Beijing needs to turn off the credit tap
Beijing must deal with shadow banking head-on rather than diverting energy to tangential matters such as regulation and deposit insurance
China's shadow banking is opaque, huge and fast-growing. In the past year, it has managed to cause two interbank crises, a few small-scale bank runs and several high-profile defaults and near-defaults of bonds.
This has all proven to be enough fun for the government, which in recent weeks has signalled a two-pronged response: tighten regulation and introduce a deposit insurance scheme. Unfortunately, both plans are misguided, in my view.
If China is really worried about shadow banking, there is a neat solution: turn off the credit tap
First, both are forms of prudential supervision, but shadow banking in China is largely a by-product of an ultra-loose monetary policy.
At the beginning of 2008, China's money supply was equivalent to only 74 per cent of the corresponding figure in the United States.
Just six years later, however, it is 61 per cent bigger, although the US economy is still 83 per cent larger than China's.
Apart from a currency translation effect, China's rapid credit growth is the key reason behind this reversal. It has taken place despite the quantitative easing in the US.