A Study on the Nonlinear Relationship Between Shadow Banking and Profitability in Chinese Commercial Banks

Abstract

This study empirically analyzed the impact of shadow banking activities on the profitability of Chinese commercial banks under an environment of continuously declining net interest margins following the 2015 interest rate liberalization. Using panel data constructed from the financial statements of 138 Chinese commercial banks and applying the System GMM methodology, the analysis confirmed a statistically significant inverted U-shaped nonlinear relationship between shadow banking and profitability in Chinese commercial banks. The effect of shadow banking on profitability exhibited pronounced heterogeneity across bank type, size, operational efficiency, and capital adequacy, with small banks in particular showing greater sensitivity to shadow banking activities. This study makes a theoretical contribution by extending the traditional financial intermediation theory, the cost-side logic of portfolio diversification, and the financial instability hypothesis to the context of shadow banking, thereby providing empirical evidence of a nonlinear dynamic relationship. From a policy perspective, the findings call for a shift away from uniform regulation toward a differentiated regulatory framework that accounts for bank type, size, and operational characteristics, with particular emphasis on enhanced monitoring of small and medium-sized banks and stricter regulation of shadow banking participation by low-efficiency and low-capital banks.