Expect more regulation of China's shadow banking in the post-Third Plenum economy, some experts say.

Michael Martin, a specialist in Asian affairs for the Congressional Research Service of the Library of Congress, said at a conference on Chinese capital markets that he anticipates the China Banking Regulatory Commission will begin regulating shadow-banking activity.

"For those of you awaiting grand liberalization and sort of 'opening up the doors,' I think it's moving the other way," he said. "You'll see more regulations coming out, trying to define the scope of shadow banking," a system where non-bank institutions provide services similar to traditional commercial banks but are not supervised like a bank.

JPMorgan estimated in May that China's shadow banking industry is now worth almost 70 percent of the country's GDP, at approximately 36 trillion yuan ($5.86 trillion).

Cindy Li, an analyst at the Federal Reserve Bank of San Francisco, said at the conference on Friday that from a financial-stability point of view, China's non-banks weren't subject to the same level of regulation and oversight by financial regulators, leading to insufficient data on the sector.

The shadow-banking sector contributes to the "imbalance" in the Chinese economy, something the country's top leaders are trying to fix, Li said.

"This imbalance will probably not go away until the government makes substantial progress on a number of fronts," she said. "Before that happens, what we'll continue to see is that in response to the existing and new regulations, the market will just respond by evolving into new business models, and that's what we saw in China the past couple of years."

She said that shadow banking had always existed in China, but the sector's rapid growth took off after the financial crisis hit in 2008.

Return on investments started to trend down between 2009 and 2013 and in tandem with the economy slowing down, bank regulators started to tighten bank-lending standards, she said. "The repressive banking system in China has provided the soil for shadow banking to grow," Li said.

Shadow banking, Li said, expanded because there were people willing to pay double-digit interest rates and still could not get bank loans, and shadow banking was there to placate demand in the market.

The bigger concern, said Martin, is that off-the-book activity from shadow banks poses a risk to existing banks. "This activity, which we had previously thought was inconsequential, is very consequential," he said.

In June, lending between banks froze when rates spiked to 25 percent, which news agency Xinhua confirmed was "partially engineered" by China's central bank in an attempt to curb shadow banking.

The severe cash crunch sent markets into panic, after which the People's Bank of China reduced borrowing costs back to normal. The credit crunch, Xinhua said, could "be just the beginning of the pain caused by curtailing shadow banking, a bandage necessary for ensuring the health of the financial system of the world's second largest economy."

Carl Walter, former COO and CEO of JPMorgan's China-banking subsidiary, took a more positive stance on the country's shadow banking sector.

"My view on shadow banking in China is that - with certain caveats - it's a good thing, at least for foreign bankers in China potentially," he said. "It's so exceptionally difficult to compete in China if you're a foreign financial institution."

Walter noted that foreign financial institutions hold less than 2 percent of Chinese financial assets, so the only way they can compete is "when the policy environment permits you to do so."

amyhe@chinadailyusa.com