The unintended cost of financial regulation in China: The impact of the new regulation on asset management on private firms' credit spreads

Abstract

Over the past two decades, shadow banking has expanded rapidly in many countries and governments have begun to take measures to deal with the financial risks shadow banking may create. Using the New Regulation on Asset Management (NRAM) policy introduced in China, we explore the unintended impact of financial regulation on the bond credit spreads between private firms and state-owned enterprises (SOEs). We find that after NRAM was introduced, the bond credit spreads between private firms and SOEs rose by 54 basis points, on average. Mechanism tests show that NRAM widens the bond credit spreads between private firms and SOEs by tightening bank credit resources and reducing firms' access to shadow bank financing. Heterogeneity analyses reveal the bond credit spreads between private firms and SOEs is larger in regions where informal financing was more developed before NRAM, and can be mitigated in regions where the formal financing environment is more friendly. We show the bond credit spreads between private firms and SOEs is higher for bonds without put option, smaller firms and firms with higher information asymmetry. We further find private firms have higher probability to provide guarantee after NRAM. Our findings provide empirical evidence on the impact of financial regulation on bond pricing and have some policy implications on establishing a reasonable financial regulatory system in emerging markets.