The Risk of Implicit Guarantees: Evidence from Shadow Banks in China*.

The article investigates how risks from shadow banking activities spill over to traditional banks through implicit guarantees, focusing on China's wealth management products (WMPs), the largest component of its shadow banking sector. Using comprehensive data linking WMPs with interbank negotiable certificates of deposit (NCDs), the study finds that banks facing higher interbank borrowing rates—reflecting greater perceived credit and liquidity risks—strategically provide stronger implicit guarantees to meet WMP target returns, thereby building reputations and reducing rollover costs. Empirical evidence supports a reputation mechanism whereby banks with weaker reputations or greater rollover pressures respond more strongly to borrowing costs by extending guarantees, which in turn lowers the likelihood of WMP shortfalls. The findings highlight the role of transparent interbank borrowing rates as timely indicators for regulators to assess "step-in" risks from implicit guarantees and suggest a bank-specific regulatory approach that accounts for heterogeneity in perceived bank risks.