China’s Bank Liquidity Creation

This research focuses on the banking system in China, the important indirectchannel of financing. With the methodology constructed by Allen Berger, it initiallyquantifies the liquidity creation to the public by42banks from2003to2010andcompares both absolute form and relative form among different types of banks knownas state-owned, joint-stock and urban commercial banks. Afterwards, panel regressionmodel is constructed to explore how monetary and regulatory policies will influencethe liquidity creation in relative form. It’s verified that the increase in reserve ratiowill significantly decrease liquidity creation while banks are insensitive to the changein interest spread. As a result of the positive effect of loan-to-deposit ratio on liquiditycreation, the upper limit on this ratio will adversely influence the efficiency of banks,thus in need of modification. Finally, the concept of liquidity creation is extended tothe capital market. By expanding CAPM into two-factor pricing model, it’s verifiedthat banks with higher efficiency to create liquidity do not perform statistically betteron the stock market after controlling for the market risk factor. On the other hand,individual components of liquidity creation such as loan growth rate and depositgrowth rate have significantly positive impact on the market return. Besides, beta inthe regression model implies that the banking industry is cyclical instead of defensive.