This study examines the effects of shadow banking on bank efficiency using data onChinese commercial banks during the period 1998–2012. I focus on two aspects: shadowbanking activities inside and outside the commercial banks. Stochastic frontier analysis(SFA) is used to analyze the effects of shadow banking on cost-efficiency. The empiricalresults indicate that the higher relative size of shadow banking inside the commercialbanks, the higher bank cost-efficiency is, while the higher relative size of shadow bankingoutside the commercial banks, the lower cost-efficiency is. This shows that there are gainsfrom shadow banking for the Chinese financial system. It is important for policymakers torealize this but at the same time understand that shadow banking likely implies a tradeoffbetween flexibility for the banking sector and higher risks.