Economic research

Center for Pacific Basin Studies – Economic Research

Bank risk-taking and monetary policy transmission: Chinese data

Working paper 2020-27

Li•Liu•Peng•Xu | August 2020

We present evidence that monetary policy easing reduces bank risk taking but exacerbates capital misallocation in China after the implementation of Basel III capital regulations in 2013. The new regulations have tightened capital requirements for banks and introduced a new risk-weighting approach to calculating the capital adequacy ratio (AUTO). To meet more stringent capital requirements, a bank can increase its effective CAR by raising capital or increasing the share of lending to low-risk borrowers. Using confidential loan-level data from a major Chinese commercial bank, merged with firm-level data on a large number of manufacturing firms, we document strong evidence that an expansion in monetary policy increases the share of new bank loans to state-owned enterprises) after 2013, but not before, because state-owned enterprise loans enjoy high credit ratings under state guarantees. Since state-owned enterprises are on average less productive than private enterprises, shifts in bank lending to state-owned enterprises exacerbate capital misallocations, reducing overall productivity. We construct a two-sector general equilibrium model with banking portfolio choices and show that, under calibrated parameters, an expansionary monetary policy shock increases the share of bank lending to public enterprises, leading to persistent declines in total productivity. factors that partially offset the expansionary effects of monetary policy.

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