The regulation was issued in March 2016 and was intended to eliminate subprime borrowers and speculators and therefore contain the property buying frenzy. But the bubble persists.

The continuation of the bubble is largely due to investors having few other investment options. This has in turn reinforced the vast shadow banking sector, which includes peer-to peer-lending companies. This sector has become increasingly risky and threatens China’s market liberalisation efforts.

The shadow banking sector in China encompasses the non-bank financial sector and to some extent the formal banking system. The sector includes financial products such as wealth management products, trust loans and peer-to-peer online loans. Such products pose a challenge to regulators due to their lack of transparency, high risk and increasing significance in the real economy.

Peer-to-peer loans, for their part, help provide funds for down payments on new homes and promise a quick return on real estate. But these loan platforms are now forbidden from extending down payment loans — an area in which the new regulation has been effective. Earlier this year, Daniel Ren at the South China Morning Post suggested that ‘17 companies [out of 20 that were offering the service] halted lending to those who seek loans for down payments’.

The crackdown on peer-to-peer down payments was part of larger regulatory enforcement in the US$93 billion online lending sector. ‘Problem platforms’ comprise 43 per cent of all platforms and numbered 1,778 as of August 2016. Regulation has focused on limiting borrowing amounts and ensuring that peer-to-peer platforms use third-party banks as fund custodians. Enforcement has resulted in police raids and the closure of many peer-to-peer online lenders. For example, in September 2016 police seized documents of Shanghai Kuailu Investment Group on suspicion of illegal fundraising.

But prices in the real estate sector continue to rise as money pours steadily into property. Few other investment alternatives promise decent returns because China’s markets are underdeveloped and the state has a strong presence in the financial system. One of the most popular investment outlets, wealth management products, falls directly into the shadow banking domain.

Wealth management products (WMPs) amounted to RMB26.3 trillion (US$3.9 trillion) by the end of 2015 and many of these products are sold by banks and other financial institutions. These products include asset bundles such as equities, bonds and entrusted loans. They have become increasingly risky, incorporating non-performing loans that are sold as trust beneficiary rights (TBRs) or other wealth management products. While the government has cracked down on incorporating non-performing loans as TBRs, practices like this still persist.

Government involvement in the shadow banking sector is unclear. In the past, authorities have bailed out failed products such as WMPs, but bailouts are far from guaranteed. Neither is the enforcement of interest, as illustrated by a recent case where New China Trust — in an attempt to recover equity investment from a real estate developer — lost a lawsuit. The equity investment was viewed by industry experts as a loan, since it contained a stock repurchase agreement. But the courts did not support this understanding. Inconsistent bailouts and insufficient support for shadow banking interests renders investment in this sector risky and uncertain.

But a lack of alternatives has made the shadow banking sector a go-to resource for borrowers and investors alike. The stock market volatility that rocked China in June 2015 still resonates and investment in stocks has not fully recovered from the freefall that took place as the asset price bubble burst. Bond markets are shallow and corporate bonds tend to be overrated. The banking sector is associated with low returns on deposits and is also constrained in lending — it continues to prefer state-owned and larger firm borrowers at the expense of private and smaller firm borrowers.

China’s efforts to liberalise its financial sector and further open up to market forces have been marginally successful but insufficient in the face of increasing demand for returns and loanable funds. Firms and residents are increasingly financially savvy and wish to reap returns on their savings, but this is especially tough in an economy where interest rates and risk ratings do not always reflect real alpha and beta. As a result, we can expect to see asset price bubbles recur. The shadow banking sector will continue to grow in a climate that is failing to integrate market forces into financial products.

Sara Hsu is Assistant Professor of Economics at the State University of New York and Research Director at the Asia Financial Risk Think Tank, Hong Kong.