Abstract
This is the first of a pair of chapters opening the ‘black box’ of the banking system to understand the transmission mechanism through which the People’s Bank of China tried to influence its money and credit intermediate target variables. Here we discuss two unsatisfactory visions of the process: the simple bank money multiplier approach, and the ‘industrial organisation’ framework treating banks as intermediaries of ‘funds’ between depositors and borrowers. Chinese policymakers rejected both of these ways of looking at policy transmission through banks.
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Notes
- 1.
Note that an individual bank may be both a lender and a borrower on the interbank market: For example, it may have lent longer term, but needed to borrow at a shorter maturity to cover a reserve shortfall. Note also that when we discuss ‘banks’ here, unless otherwise stated we include the range of institutions counted as ‘other depository institutions’ in official Chinese statistics (i.e., ‘other’ than the PBC itself), which includes bank-like institutions such as rural credit cooperatives.
- 2.
Both M2 and the volume of bank loans have exponential growth trends, so must be detrended for a meaningful measure of their relationship. We took natural logarithms of both variables to linearise the trends. We then obtained detrended variables by regressing each on time (months since beginning of the series) and taking the residuals. The R-squared for the relationship between (log) M2 residuals and (log) loan residuals over the whole period January 1997–December 2008 is 0.52. This indicates that variation in loans around its trend accounts for about half of the variation in M2 around its trend. The relationship is much tighter for the sub-period July 2001–December 2008, i.e., after the period of abnormally low loan growth associated with the aftermath of the Asian crisis. For this sub-period, R-squared is 0.75.
- 3.
These three categories together—in roughly equal proportions—account for most of the difference between the growth in deposits and the growth in loans in the year to March 2001. On the liability side, there is also a sizeable decline in bank borrowing from the central bank. Bank balance sheet data is patchy before 2002, and there are two more series changes in official statistics between then and 2008, so we have not attempted to construct a table or chart representing balance sheets for the whole period. We draw this PBC data from the CEIC China Premium database Table CN.KC, ‘Deposit money bank’ assets and liabilities. We focus on the year to March 2001, because later that year there is a large change in the unidentified ‘Net other item’ category, representing a discrepancy between recorded assets and liabilities. This probably corresponds to items added in the next series beginning in 2002, including foreign currency deposits, interbank assets/liabilities, and ‘other assets’.
- 4.
For data to the end of 2005 refer again here to the ‘Deposit money bank’ assets and liabilities series in CEIC Table CN.KC. Figures in this period are more complete than for before 2002, but again by the end of 2005 discrepancies are accumulating, and the ‘Deposit money bank’ series ends there. From there the ‘Other depository corporation’ series begins (‘Other’ here means ‘other than the central bank’).
- 5.
The textbook Governor Dai distributed at the PBC is typical in this respect, first setting out the multiplier and then explaining that ‘the actual creation of deposits is much less mechanical than the simple model indicates’ (Mishkin 1995, p. 379, and see pp. 367–433).
- 6.
The money multiplier relationship is derived as follows: If M2 is the monetary aggregate of interest, including currency and all deposits, and MB is the monetary base, then the money multiplier is the ratio of M2 to MB (m = M2/MB). M2 is made of currency in the hands of the public (C) and deposits (D) (M2 = C + D). The monetary base is made up of currency in the hands of the public (C) and reserves (R) (including currency held by the banks and bank deposits with the central bank) (MB = C + R). Let k be the currency-deposit ratio (k = C/D). Let r be the bank reserve-deposit ratio (r = R/D). Then m = (C + D)/(C + R) = (k + 1)/(k + r). If both k and r are constants, so will be m. If either or both vary, so will m.
- 7.
In this case, the bank balance sheet identity means that the sum of loans (L) and reserves (R) must equal deposits (D) (L + R = D). Since we assume banks maintain a stable reserve-deposit ratio (r), L = D − rD = (1 − r)D. Since M2 = C + D, and C = kD (see previous footnote), D = M2/(1 + k). Therefore, L = M2 × (1 − r)/(1 + k). Aggregate bank credit has a constant relationship to the money supply, and since the money supply has a constant relationship to the monetary base, so does credit. Specifically, the ratio of loans to the monetary base, or loan multiplier (l = L/MB), is (1 − r)/(k + r). An M2 target implies a credit target, and vice versa, with both having constant ratios to the monetary base. (If banks hold assets besides loans and reserves, this opens up another potential wedge in the loan-reserve and loan-deposit ratios, and to maintain a constant multiplier we also need to assume a constant ratio of non-loan assets to loans in order to maintain a constant relationship between loans and deposits.)
- 8.
Depositors also tended over the decade to shift a larger proportion of their money holdings from demand deposits to longer term deposits, so that the M1/M2 ratio declined by 8.2% between 1999 and 2010 (Yong 2011, p. 39).
- 9.
Included here are all deposit-taking institutions, which were all covered by the required reserve ratio—urban and rural credit unions, financial companies, investment trustee companies, and financial leasing companies as well as commercial banks. Commercial banks were by far the largest category, however.
- 10.
In other words, k followed a generally steady downward trend, but r fluctuated in a less predictable way.
- 11.
Sun’s (2015) book collects past papers written by the PBC economist, mostly unpublished. We have indicated in square brackets the year in which each paper was originally written.
- 12.
If there are economies of scope between the management of loans and deposits (e.g., if information gathered from deposits reduces the cost of information gathering for lending purposes), the deposit rate will also affect the supply of loans and the loan rate will affect bank demand for deposited funds (Freixas and Rochet 2008, pp. 73–75). The Chinese models generally abstract from such economies of scope, which complicate exposition of the model without much practical importance.
- 13.
At the end of 2005, commercial banks held 70.7% of outstanding bonds, while personal investors and non-financial investors held just 0.6% and 0.2%, respectively. Households held bonds indirectly via funds (4.2%), while insurance companies held 6.7%. Most of the rest were held by non-bank financial institutions (4.5%), credit unions (2.4%), and by ‘special settlement members’ (4.9%) and securities exchanges (5.4%) (Gao 2007, p. 208).
- 14.
There is more discussion on this point in an earlier version of the paper (He and Wang 2011, pp. 13–15).
- 15.
Feyzioglu et al. (2009) tackle the related question of what would happen to the interest rate structure if bank rates were liberalised.
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Beggs, M., Deer, L. (2019). Transmission I: Inside the Banking Black Box. In: Remaking Monetary Policy in China. Palgrave Pivot, Singapore. https://doi.org/10.1007/978-981-13-9726-4_4
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