Banks’ liability structure and monetary policy transmission: evidence from a quasi-natural experiment in China

This study investigates how banks’ liability structure affects the bank lending channel of monetary policy transmission. Using a two-period model, we argue that deposit-funded banks are more inclined to provide credit than wholesale-funded banks due to a lower liquidity risk, resulting in more efficient transmission of monetary policy. To identify this causality, our difference-in-differences estimate exploits the introduction of Macro Prudential Assessment (MPA) into China’s bank regulatory system in 2016 as an exogenous shock, in which tougher regulation on wholesale funding was imposed in small banks. We find that the reform consolidates the negative sensitivity of bank loans to policy interest rate, and this effect is stronger for banks with higher risk, greater market power and lower capital adequacy. Further, using the bank-firm loan-level data, we find that a reduction in wholesale funding amplifies the real effects of monetary policy, particularly for private firms with more serious financial constraints. Our findings confirm the active role of banks’ liability structure in the effectiveness of monetary policy transmission.