Working Papers

2020-27 | May 2022

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Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China

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Loan-level evidence shows that China's implementation of Basel III in 2013 has reduced bank risk-taking both on average and conditional on monetary policy easing. However, banks reduce risk-taking by increasing lending to ostensibly low-risk but inefficient state-owned enterprises (SOEs), leading to credit misallocation. We establish these empirical results using a difference-in-difference identification, exploiting cross-sectional differences in lending behaviors between high-risk and low-risk bank branches before and after the new regulations. To understand how changes in capital regulations may affect monetary policy transmission, we construct a two-sector general equilibrium model featuring bank portfolio choices and capital adequacy ratio (CAR) constraints. The model highlights a risk-weighting channel, through which expansionary monetary policy shifts bank lending toward inefficient SOEs, consistent with empirical evidence. Under government guarantees of SOE loans, such a shift in lending reduces the portfolio risks for individual lenders, but it also reduces aggregate productivity and raises the average risk of bank insolvency.

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Article Citation

Li, Xiaoming, Zheng Liu, Yuchao Peng, and Zhiwei Xu. 2020. "Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China," Federal Reserve Bank of San Francisco Working Paper 2020-27. Available at https://doi.org/10.24148/wp2020-27