A Test Of Bank Risk-Taking Channel In China Under Price Competition

Research on the monetary policy transmission mechanism has a long history, from the traditional interest rate channel, through asset price channel and the credit channel, to the balance sheet channel. But these theories of transmission channels do not take the banks and other financial institutions' attitudes toward risk into consideration. Correspondingly, the goal of monetary policy did not cover financial stability. After the burst of Internet bubble in 2001, most of the Western countries prevented the economic from decline by cutting interest rates, under the guidance of traditional monetary policy objectives. And some even kept the interest rate below long-term equilibrium interest rate or pumped in unprecedented liquidity into the financial system. They believed that a slight inflation would contribute to economic development and would not harm the financial stability. But the financial crisis from 2007 to 2009 originating in the United States completely changed the way people viewed loose monetary policy. Loose monetary policy influences perceived degree and risk tolerance of banks, reducing the price of risk and relaxing the financing terms of borrows, thereby affecting the overall risk level of banks. Such a connection among monetary policy, financial stability and macroeconomic mechanism is known as the "risk-taking channel."In the period of economic transition, China adopted financial restraint policies to promote economic growth and relaxed monetary environment. There are four typical characteristics in Chinese monetary policy and banking regulation system. They are high proportion of mortgage in domestic banks, joint-stock reform of state-owned banks, the dependence of monetary policy on quantitative tools and commercial banks' expectation for government assistance. These characteristics make commercial banks more vulnerable to risk taking channel. Risk-taking channel effect will be affected by institutional change and market structure, changes in competition form and strength during interest rate liberalization stand in the breach. In 2003, the Third Plenum of the Party determined to marketization interest rate. The process of interest rate liberalization advanced steadily and controls of interest rate on ending market and deposit market gradually loosened since then. On July 20, 2013, the central bank cancelled the lower limit control on lending rate. Interest rate liberalization on lending market was achieved first. Liberalizing interest rate market on deposit market had become a key step. After the continuous expansion of the upper limit on deposit interest rate, the Central Bank abolished all the restrictions, interest rate liberalization on October 24, 2015, interest rate liberalization completed. Corresponding to the process of interest rate liberalization, the form of competition among commercial banks has transformed from size and organization expands to price competition gradually. This article is intended to verify the existence of bank risk channels in our country, to explore the complex relationship among commercial banks' price competition and its risk behaviors and improve the cognition of regulatory authorities to financial stability under the current monetary policy and the new competitive environment. Thus will provide recommendations to monetary policy and bank supervision.This paper reviews the theory and empirical research on risk taking channel both domestic and foreign and explains the four sub-system mechanism of the channel. According to the analysis on the domestic banking system and monetary policy, we found the possible ways that the risk taking channel may affect banks. Based on this, the paper verifies the specific mechanisms of it in China, using the data of 16 listed commercial banks during the period of 2002-2014 and GMM dynamic panel estimation method. In order to accurately measure the forms of the competition, this paper teased the processes of interest rate liberalization and use translog cost approach to measure the degree of price competition. Adopting Threshold panel model using bootstrap sampling method, the effect of price competition on risk taking channel was also studied. Finally, the article summarizes the empirical results and draw policy implications based on conclusions.The empirical results show that: first, both the growth of real estate price and return of assets have a significant effect on bank risk taking,that means search for yield mechanism and cash flows and valuations mechanism exist. Second, there is a negative correlation between price competition and bank risk taking. Finally, there is no threshold effect between price competition and risk-taking channel, which means the level of inter-bank price competition needs to be strengthened. According to the research findings, we get the following policy implications: firstly, the central bank should combine traditional monetary policy with macro-prudential policies. Secondly, commercial banks' ability on loan pricing and internal governance need to be enhanced. Finally, improve relevant laws and regulations to encourage rational price competition among banks.