Informal Finance and Ponzi Schemes

Abstract

Informal finance, including wealth management product (WMP) and private lending, has played an increasing role in China’s transition from a planned economy to a market economy. Informal finance in China has largely arisen due to lending constraints in the formal banking sector. Banking reforms, to date, have not been sufficient to allow formal institutions to supply funds to all enterprises, especially private ones. The former chairman of the BOC and current chairman of the CSRC, Xiao Gang, has characterized this “shadow banking” sector as “a potential source of systemic financial risk,” whose model is “fundamentally a Ponzi scheme” (Xiao, 2012).