HYPOTHESES
In this paper, we will test the effects of the monetary policy on banks’ risks in China. Our hypotheses concern the impact of interest rate, reserve requirement ratio and open market operation on banks’ risks in China.
Our hypotheses are different from the results of the present mainstream research. In view of the fact that interest rate is the major monetary policy instrument, the U S and European countries focus primarily the effect of interest rates on bank risks. The representative and mainstream study is the work of Delis and Kouretas (2011). They presented strong empirical evidence that low-interest rates indeed increase bank risk-taking (measured by the ratio of risk assets to total assets) substantially. In China, the representative study is the work of Yu and He (2011). They found that the RMB 1-year benchmark deposit rate the reserve requirement ratio are all negatively correlated with bank risks (the ratio of risk assets to total assets) and the effect of the former on bank risks are larger than that of the latter. However, it is a pity that Yu and He (2011) did not focus on the effect of the open market operation on bank risks and explain the difference of the effects of the interest rate and the reserve requirement ratio on bank risks.2.1. The Interest Rate
From the results of Table 2, the ratios of risk assets all banks basically increase (decline) in high (low) interest rate regime in China1. The possible reasons are as follows. Low interest rate implies the economy is down. As the economy goes down, banks would not like to take risk in engaging in the more risky asset business, which is also unnecessary for banks with the reason that low interest rate regime basically means high interest rate margin regime that implies high earnings on condition that loan-to-deposit spread is the main source of profits of the banks in China from 2000 to 2006, which can be seen in Table 2, Table 3 and Table 4.
Therefore, banks face a lower risk of default. Furthermore, when the interest rate is low, commercial banks have a low cost of the liabilities (deposits or borrowings) to the residents, the firms, the interbank or central bank, which demonstrates that liquidity risks faced by banks are likely to be small. On the contrary, the high interest rate means the economy is up, banks would like to take risk in engaging in the more risky asset business to make large earnings, which is also necessary for banks with the reason that high interest rate regime basically means low interest rate margin regime that implies declining earnings on condition that loan-to-deposit spread is the main source of profits of the banks in China. From Table 2, Table 3 and Table 4, during 1998-1999 with a high interest rate and low interest rate margin, risks of all banks are high while the earnings are low because of low management efficiency and many non-performing loans. In 2011 with a high interest rate and low interest rate margin, risks of all banks are high while the earnings are high, which is in accord with the rule-“the higher the risk is, the higher the earning.” Moreover, when the interest rate is high, commercial banks have a high cost of the liabilities (deposits or borrowings) to the residents, the firms, the interbank or central bank, indicating that liquidity risks faced by banks are likely to be high.The reason that the effect of the interest rate on bank risks differs in China and in USA lies in the fact that the degree of the interest rate marketiza- tion and the banking sector’s attitude towards risk varies in China and in USA. In China, banks are not risk-lovers and have no fully right to make the interest rate of loans and deposits float while banks are risk-lovers and the interest rate is fully
Table 2. The ratio of risk assets of all banks in different interest rate regime
| High Interest Rate Regime | Low Interest Rate Regime | ||||
| 1998- | 2007- | 2011 | 2000- | 2009- | |
| 1999 | 2008 | 2006 | 2010 | ||
| All Banks | 0.860 | 0.844 | 0.845 | 0.841 | 0.840 |
Note: The interest rate is the 1-year benchmark deposit rate.
All Banks refer to the nineteen State-owned and Non State- owned banks.
State-owned banks include the Industrial and Commercial Bank of China (ICBC), the Agricultural Bank of China (ABC), the Bank of China (BOC) and the China Construction Bank (CCB). Non State-owned banks include Bank of Communications (BOCOM), CITIC Bank, Everbright Bank of China, Huaxia Bank, Guangdong Development Bank, Shenzhen Development Bank, China Merchants Bank, Shanghai Pudong Development Bank, Industrial Bank, China Minsheng Banking Co., Evergrowing Bank, Beijing Bank, Shanghai Bank, Nanjing Bank and Ningbo Bank.
Table 3. The ratio of risk assets of all banks in different interest rate margin
| 1998-1999 (Low Interest Rate Margin) | 2000-2008 (High Interest Rate Margin) | 2009-2011 (Low Interest Rate Margin) | |
| All Banks | 0.860 | 0.842 | 0.844 |
Table 4. The ROA of all banks in different interest rate margin
| 1998-1999 (Low Interest Rate Margin) | 2000-2008 (High Interest Rate Margin) | 2009-2011 (Low Interest Rate Margin) | |
| All Banks (%) | 0.363 | 0.587 | 1.029 |
Note: ROA means Return On Assets and is calculated by dividing net profit by the average balance of total assets at the beginning and at the end of the reporting period.
market-oriented in USA. Therefore, when the interest rate declines that means loose monetary conditions, banks in China have less freedom in the changes in the interest rate and take less risk than banks in USA.
Table 3 shows that risks of all banks are high (low) as the margin is low (high). The probable reasons are listed below. High (low) interest rate margin implies high (low) earnings on condition that loan-to-deposit spread is the main source of profits of the banks in China.
Thus, banks in China with high (low) earnings would like to engage in less (more) risky businesses.Hypothesis 1: The interest rate has a positive effect while the interest rate margin has a negative effect on bank risks in China.
2.2. The Reserve Requirement Ratio
In China, bank risk increases when the reserve requirement ratio is low while bank risk declines when the reserve requirement ratio is high. The possible reasons are listed below. The low reserve requirement ratio implies the increase in the available funds of the banks. As an administrative command, the low reserve requirement ratio is a strong signal of stimulating the expansion of the banks’ loans and other asset business, which may make banks relax their vigilance to engage in some high-risk businesses to make high earnings and may cause higher bank risks. When the reserve requirement ratio is high, the available funds of the banks decline. As an administrative command, the high reserve requirement ratio is a strong signal of inhibiting the expansion of the loans and other asset business, the banks have high vigilance to decrease the probability of engaging in high-risk businesses to make high earning, leading to a decline in bank risks.
Hypothesis 2: The reserve requirement ratio has a negative effect on bank risks in China.
2.3. The Open Market Operation
In China, open market operation mainly relates to the commercial banks’ business of trading government bonds which is a relatively risk-free asset. The lower bank risk is, the larger the scale of open market operation is in China.
Hypothesis 3: The open market operation has a negative effect on bank risks in China.
3.