Monetary Policy Transmission Channels And Bank Stability

The “financial instability hypothesis” proposed by Minsky(1982) states that banking industry has its intrinsic instability as bank’s high level of operating liabilities. The proportion of riskpreference and speculating borrowers rises during economic expansions to such a high level that frequent default could be triggered, followed by massive bankruptcies throughout the banking sector and eventually the outbreak of financial crises. Numerous theoretical and empirical studies showed that financial crises are often caused by banking crises, ineffective monitoring of commercial bank, for instance, has been seen as one of the major causes of US subprime crisis. Hence bank stability is the key to financial stability. However, there has been no explicit agreement on the measurement of bank stability and its impacts so far, nor are there intensive studies on the influence mechanism of monetary policies and the role of regulation in bank stability. Therefore, the implement of macroprudential tools have been constrained. Although financial crisis initiated by intrinsic risk has not been seen in China, instability in the financial system has grown obvious these years, indicating continuously accumulating risks.Given the facts listed above, this article, based on theories of bank stability and related research on Monetary transmission channels, is going to deal with a systematic study on the following aspects: the formulation of Chinese bank soundness indicators, the impacts of channels of monetary policies on bank stability and the spillover effect of systematic risk on the banking sector. The core analysis of this work lies on Chapters 3, 4 and 5, namely the investigation into the relationship between transmission channels of monetary policies and bank stability The transmission channels from monetary policies to financial vulnerability fall into three categories: bank lending channel, borrower balance sheet channel and bank capital channel. The detailed contents are outlined below:Chapter 1 concluded the backgrounds, framework and relative research and other circumstances of this paper, together with the statements of bank stability and monetary transmission mechanism theories. Chapter 2 summarizes existing methods of bank stability measurement which leads to a most suitable bank stability indicator for permanent China banking system, based on a comparison between different soundness measurements and the soundness indicator system with the formulation of soundness factors. Z-score performs well in foreign research,however not for recent domestic bank data. Thus for a reasonable evaluation of bank stability, generalized dynamic factor model were introduced to domestic listed bank data and different estimation methods like principal component analysis, Kalman Filter method and EM algorithm were applied.In Chapter 3, it is presented that the borrower balance sheet channel deals with the borrowers’ financial performance and their external financing costs. Changes in interest rate and money supply leads to an increase in the corporates’ financing costs, including agency cost, and worsens their balance sheet status, thus cause a decline in their reimbursement capacity and moral hazard. Given the non-stationarity and latent structural instability of Chinese bank stability statistics and monetary policy time series, in this chapter an infinite-state-regime-time-varying VAR model is established to discuss the time-varying dynamic structure of bank stability and monetary policies. Empirical results show that considering only the relationship between monetary policies and bank soundness, interest rate has a positive first-order lagged effect on bank stability. There exists significant firstorder and second-order lagged time-varying causality relationship between M2 growth and bank stability, while the coefficients of the lagged terms are time-varying but show no explicit regimeswitching properties. Further analysis on the role of borrower balance sheet channel in the transmission process from monetary policies to bank stability, which is conducted by establishing multi-parameter time-varying models of the transmission via bank credit risk to bank stability separately from interest rate and money supply, shows that credit risk acts as an important transmitter in the process of interest rate changes influencing bank stability. The time-varying coefficients of interest rate and money supply exhibit obvious regime-switching properties during the time period of financial crises.In Chapter 4, it is stated that the amplification of capital adequacy ratio to monetary policies leads to increased financial instability according to bank capital channel theory. Due to the inherent procyclicality of bank capital, the bank capital channel similarly caused procyclicality in bank soundness and macro economy, thus the framework of countercyclical capital buffer was proposed in Basel III. This chapter studies the influence of regulatory capital to bank soundness under different monetary policies,involving variables like interest rate, time-varying regulatory capital and financial condition index. A latent threshold vector autoregression model with time-varying parameters(LT-TVP-VAR Model) is formulated to examine the influence of countercyclical capital regulations on domestic bank soundness. Empirical result shows that varying regulatory capital has a positive lagged effect on bank soundness and this coefficient increases significantly after the trial capital regulations was introduced in 2013, which means there has been an increased positive effect caused by countercyclical capital regulation. This positive effect applies to all three types of commercial banks this study concerns, while significantly time-varying coefficients vary greatly among different banks. While state-owned commercial banks are most influenced by the changes in capital regulations, minor changes occurred on joint-stock commercial banks. The implementation of countercyclical regulatory capital requirements improves bank soundness. That is to say, implementing countercyclical regulatory capital requirements helps diminish the financial procyclical problems and ensures the stability of banking system and economic steadiness.Chapter 5 states that the bank lending channel is the transmission process to the real economy via credit supplies. In this chapter, the distribution effect and the time-varying features of bank lending channel are studied with banks categorized according to their levels of soundness. A paneldata TVP-VAR model with controlled variables is established and used to estimate the regimeswitching structure of monetary policies influencing bank credit activities. Results show that banks with greater soundness are less impacted by interest rate changes while this impact is larger for banks with lower levels of soundness. This means a distribution effect exists within the reaction of bank lending to interest rate changes. The reaction to interest rate changes of all banks shows regime-switching properties, which appears more significant for banks with higher risks.The last section of this article examines the relationship between the characteristics of bank governance and bank soundness. Deficient bank governance leads to an imperfect risk-control system; thus the effectiveness of bank governance has a direct influence on the risk condition of the banks. In this section, multiple variables on bank governance are chosen from both aspects of governance structure and shareholding characteristics and then combined into a bank governance characteristic factor with the generalized dynamic factor model. After that a SVAR model is constructed to analyze the influence of bank governance characteristics to bank soundness. Result shows that the bank governance efficiency factor has a positive impact on bank soundness for both state-owned banks and joint-stock banks, while the bank governance inefficiency factor has a shortterm negative impact.To be conclude, in this paper, econometric methods are adopted and an analysis is given on the relationship between transmission channels of monetary policies and bank soundness, as well as how regulation and supervision works to influence this relationship. The whole work helps to understand bank stability issues in financial system, and the mechanism of monetary policies influence bank stability. Using time varying macro-econometric models and panel-data models on the frontier of research, we analyze the instability of banking system triggered by monetary policies and business cycle, which contributes to prevent systematic risk in banking system, and to develop macro-prudential regulation tools so as a steady growth of the economy.