The Study Of The Effect Of The Interest Rate Liberalization On The Stability Of Chinese Banking System

The interest rate liberalization of China has lasted for almost 30 years. Till now, China has achieved interest rate liberalization in its monetary market, bond market, foreign currency deposits and loans market and the RMB loan market. It is expected that, as the last part of the interest rate liberalization reform, the RMB deposit market liberalization is going to be achieved in the following two years.Foreign countries’ interest rate liberalizations show that the interest rate liberalization reform will lead to changes in the relationship between the variables in the financial markets. In the short term, it may strike the financial system and the stability of the banking system. However, in the long term, the interest rate liberalization is widely considered to be effective in increasing savings, improving the efficiency of investment, accelerating financial deepening and promoting economic growth. Therefore, how does the ongoing interest rate liberalization impact on Chinese banking system? What is the path? What should the commercial banks of China do to deal with the interest rate liberalization?Some scholars research the effect of interest rate liberalization on the stability of banking system from the point of interest rate risk or credit risk. A few other scholars make use of real interest rates to take the place of interest rate liberalization progress. However, this paper aims to find the index that can really reflects the gradual process of interest rate liberalization. In order to make proper analysis of the effect of interest rate liberalization on the stability of banking system, this paper theoretically analyzes the transmission mechanism of the effect, and then empirically tests the degree of the effect and transmission mechanism.To quantitatively describe the process of interest rate liberalization, the paper constructs the interest rate liberalization index to reflect the process of marketization. Firstly, we select six interest rates of different submarkets to establish evaluation system of interest rate liberalization; secondly, we make assignments based on the effect of major policies and events on the interest rate liberalization progress; finally, we complete the construction of interest rate liberalization index using principal component analysis. This Index shows the gradual process of marketization of interest rates, which has completed nearly 70% in 2013. There are three accelerating periods: from 1996 to 2000, from 2003 to 2005 and from 2013 to today. This index is considered to have a good explanation of the interest rate liberalization progress, and consistent with the macro economy.To construct the proper index to reflect the stability of Chinese banking system, this paper select eight indicators of four sorts to build comprehensive index take the advantage of the international assessment system. The results show that from 2003 to 2012, the stability of Chinese banking system has an upward trend as a whole. However, it declines in two periods which are from 2007 to 2009 and from 2010 to 2011. The former period is due to the impact of the financial crisis, and the latter period may be the aftermath of China’s 4 trillion investment plans.In the empirical test, the paper introduces the above interest rate liberalization index, and establishes a regression model to quantitatively analyze the effect of interest rate liberalization on the stability of the banking system. In addition, we add cross terms in the model to test transmission mechanism of the effect. The main conclusion is that the interest rate liberalization has a significant negative effect on the stability of China’s banking system. As to transmission mechanism, with the increasing of real interest rates, the interest rate liberalization will quicken the decline of the stability of China’s banking system. Rising of real exchange rate has the same effect. Thus, changes in interest rates and exchange rate will enhance the effect of interest rates liberalization process on the stability of China’s banking system. In addition, there is significant different between effects of interest rate liberalization on state-own banks and non-state banks. The latter will suffer more severe effect than state-own banks.The trend of interest rate liberalization is inevitable, so the commercial banks should actively adjust its mode of operation. This paper provides the appropriate recommendations, including developing intermediary business, strengthening the management of interest rate risk, accelerating internationalization and so on.