CONCLUDING REMARKS AND POLICY IMPLICATIONS
We use panel data regression model to study the effects of main monetary policy instruments on commercial bank risk in China. The empirical findings are as follows. The effects of the interest rate, the reserve requirement ratio and open market operation on bank risks are all statistically significant.
The interest rate is positively correlated with bank risks, while the interest rate margin, the reserve requirement ratio and open market operation are both negatively correlated with bank risks. Among the three monetary policy instruments, the reserve requirement ratio, the interest rate (the interest rate margin) and open market operation have respectively the greatest, the middle and the smallest effects on bank risks. The effects of the interest rate and the reserve requirement ratio on bank risks are different with the probable reason that the interest rate affects not only the amount of banks’ available funds but also the cost of banks’ liabilities and the effect is slow and complex while the reserve requirement ratio as an administrative command directly and mainly impacts the amount of banks’ available funds and the effect is rapid and obvious.Considering the different effects of the interest rate (the interest rate margin), the reserve requirement ratio and open market operation, and the significant effect of the reserve requirement ratio on bank risks, the following policy implications can be obtained. First, applying the administrative and market-oriented monetary policy instruments simultaneously and synthetically is helpful for achieving price stability and financial stability synchronously. About the relationship between price stability and financial stability, there are two conflicting viewpoints. One is “synergy” viewpoint that monetary policy aiming at price stability will be conducive to financial stability (Schwartz, 1995).The other is “trade-off” viewpoint that monetary policy aiming at price stability is not necessarily helpful for financial stability and a trade-off relationship exists between price stability and financial stability (Borio & Lowe, 2002; Schinasi, 2003).
From China’s experience, on the one hand, price stability can be achieved by enhancing the interest rate and reserve requirement ratio at the time of high inflation. On the other hand, the increase in the interest rate leads to the increase in bank risk while the rise in the interest rate margin or the reserve requirement ratio results in the decline in bank risk. What’s more, the effect of the reserve requirement ratio on bank risks is greater than that of the interest rate or the interest rate margin. Utilizing mainly the reserve requirement ratio rather than the interest rate or the reserve requirement ratio, the interest rate and the interest rate margin are applied at the same time will contributes to achieve price stability and banking stability simultaneously. Therefore, the reserve requirement ratio(an administrative instrument) sometimes may play a more major role than the interest rate(a market-oriented instrument) and the market is a good but not necessarily a best choice, which is important for those countries that take the interest rate as a principal instrument and ignore the use of the reserve requirement ratio. Second, the following measures should be taken to ensure the financial stability. To begin with, banks ought to pay much attention to the impact of the changes in monetary policy on bank risks and establish a comprehensive early warning system of risk. Next, the monetary authorities should improve its reaction function and take the bank sector into macroeconomic decision-making model, and strengthen the monitoring and analysis of bank risks and thus guard against financial imbalances. Again, the monetary authorities ought to focus on the effects of the interest rate margin more than the interest rate per se on bank risks with the reason that the interest rate has a positive effect on bank risks on the premise that low interest rate regime means the high interest rate margin in China in our empirical study. To keep a reasonable interest rate margin is more important than to focus on the level of the interest rate alone. Then, monetary and regulatory authorities must take into account the different effects of the interest rate (the interest rate margin) and reserve requirement ratio on bank risks and strengthen coordination and cooperation so that some effective steps can be taken in advance to prevent the possible risks.ACKNOWLEDGMENT
Thanks to the financial support by National Natural Science Foundation of China (Grant No. 71103048) and National Natural Science Foundation of China (Grant No. 71273224).
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ENDNOTES
1 The interest rate is the RMB 1-year benchmark deposit rate. Margin equals the RMB 1-year benchmark loan rate less the RMB 1-year benchmark deposit rate.
2 We do not use LIR as the explanatory variable with the reason that DIR and LIR have the same trend and their correlation is as high as 0.953. If DIR or LIR less its mean is more(less) than zero in some year, the year is high (low) interest rate regime. If Margin less its mean is more(less) than zero in some year, the year is the period of high (low) interest rate margin.
This work was previously published in International Journal of Asian Business and Information Management (IJABIM), 4(2); edited by Patricia Ordonez de Pablos, pages 57-71, copyright 2013 by IGI Publishing (an imprint of IGI Global).
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