An analysis of involuntary excess reserves, monetary policy and risk-taking behaviour of Chinese Banks

Abstract

In this paper, we examine the effects of monetary policy on the risk-taking behaviour of Chinese banks in the presence of involuntary excess reserves based on a sample of 95 banks. We find that involuntary excess reserves lead to more aggressive risk-taking suggesting that large involuntary excess reserves stimulate the rapid expansion of credit and the price bubble in the Chinese financial market. However, banks with larger involuntary excess reserves tend to reduce risk-taking more rapidly under the tightening monetary policy regime. The paper sheds light on the effectiveness of government monetary policy in reducing the risk-taking behaviour of banks in an emerging market where involuntary excess reserves are present.

The Coexistence and Interaction of Formal and Informal Lending in China— Discussion of the Wenzhou Case

“…Over 4 trillion RMB was injected into the economy, and this involved also a directive to the state controlled banks to rapidly expand credit availability to support output and demand. As observed by Nguyen and Boateng (2015), there is a close relationship between the government's monetary policy changes and risk-taking behaviour by Chinese banks. The rapid change in policy in a system used to top-down hierarchical lines of authority lead rapidly to pressure on bank loan officers to meet expanded loan quotas.…”

Bank Liquidity and Exposure to Industry Shocks

“…In the same line, empirical evidence suggests real GDP growth tends to display a positive relationship with loan supply (Nguyen and Boateng, 2015;Davydov et al, 2018). This relationship has been documented by a large body of literature, arguing that positive credit cycles consist of periods of good economic performance and robust credit growth, as well as better investment opportunities.…”

Excess Liquidity and Bank Managers’ Remuneration: The Role of Monetary Policy

“…We examine the impact of monetary policy on remuneration of bank managers in Vietnam and China as the excess liquidity condition is prominent in these two countries (see [1] [2] [3] [9]). The study contributes to the literature of monetary policy and risk-taking behaviours of commercial banks in the context of emerging economies experiencing excess liquidity condition (see [8] [14]).…”

“…This is because the central banks increase money supply to neutralize the currency appreciation pressure [2] [3] [5]. For example, the literature has documented that excess reserves in the Chinese banking system averaged around 10% of deposit during 2000s and remained high at 3.3% during 2012 [6] [7] [8]. In Vietnam, the excess liquidity has been argued to lead to high inflation rate to around 18% during 2010s [1] [2] [9].…”

“…The literature has raised concerns that excess liquidity condition, i.e. the oversupply of money beyond optimal level, may induce risk taking behaviors of commercial banks, and hence, lead to financial instability (for example, [8] [10]). [10] posit that excess liquidity forms the perception of low illiquidity risk among bank managers, who tend to lend out aggressively to improve their remunerations.…”