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Interest rate liberalization and bank liquidity creation: evidence from China

Author

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  • Jiaming Zhang
  • Xiangrong Deng

Abstract

Purpose - This study aims to empirically analyze how interest rate liberalization affects bank liquidity creation, and investigate whether the relationship between them is linear. Design/methodology/approach - Based on panel data on 145 banks in China over the period 1997–2015, this paper regresses the econometric model by conducting feasible generalized least square estimation. Findings - The regression results show that, first, interest rate liberalization has a nonlinear impact on bank liquidity creation, and the relationship between them is inverted U-shaped. In other words, as interest rate liberalization progresses, bank liquidity creation increases first, and then decreases. Second, through the mediation effect tests, this study found that interest rate liberalization affects bank liquidity creation through bank risk-taking. That is, interest rate liberalization leads to changes in bank risk-taking, thus resulting in changes in bank liquidity creation. Research limitations/implications - The effect of interest rate liberalization on bank liquidity creation is nonlinear, so promoting interest rate liberalization faces a trade-off because excessive bank liquidity creation may lead to asset price bubbles, while insufficient bank liquidity creation may inhibit economic growth. Practical implications - Interest rate liberalization has a significant impact on bank liquidity creation; therefore, bank liquidity creation should be added to the objective function of the regulator that determines interest rate liberalization reform in China. Social implications - Interest rate liberalization has a direct impact on bank risk-taking, so the consequences of interest rate liberalization should be included in the framework of macro-prudential supervision. Originality/value - Interest rate liberalization is one of the most important financial reforms in China, yet its potential impact on firm-level bank liquidity is little explored. This paper attempts to fill the gap.

Suggested Citation

  • Jiaming Zhang & Xiangrong Deng, 2020. "Interest rate liberalization and bank liquidity creation: evidence from China," China Finance Review International, Emerald Group Publishing Limited, vol. 10(4), pages 377-391, March.
    • Handle: RePEc:eme:cfripp:cfri-06-2019-0081
    DOI: 10.1108/CFRI-06-2019-0081
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    Citations

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    Cited by:

    1. Tang, Ying & Li, Zhiyong & Chen, Jing & Deng, Chao, 2021. "Liquidity creation cyclicality, capital regulation and interbank credit: Evidence from Chinese commercial banks," Pacific-Basin Finance Journal, Elsevier, vol. 67(C).
    2. Wei, Xin & Liu, Xi & Zhang, Xueyong, 2022. "Shadow banking and the cross-section of stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 81(C).
    3. Chen, Xiaohui & Shen, Shaowei, 2024. "Probability causal inference of interest rate fluctuations: Evidence from private credit in emerging markets," Technological Forecasting and Social Change, Elsevier, vol. 200(C).
    4. Tuna, Gulcay & Almahadin, Hamed Ahmad, 2021. "Does interest rate and its volatility affect banking sector development? Empirical evidence from emerging market economies," Research in International Business and Finance, Elsevier, vol. 58(C).
    5. Xiaowei Kong & Deng-Kui Si & Haiyang Li & Dongmin Kong, 2021. "Does access to credit reduce SMEs’ tax avoidance? Evidence from a regression discontinuity design," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 7(1), pages 1-23, December.
    6. Dilesha Nawadali Rathnayake & Yang Bai & Pierre Axel Louembé & Li Qi, 2022. "Interest Rate Liberalization and Commercial Bank Performance: New Evidence From Chinese A-Share Banks," SAGE Open, , vol. 12(2), pages 21582440221, May.
    7. Chen, Shenglan & Ma, Hui & Teng, Haimeng & Wu, Qiang, 2022. "Banking liberalization and corporate tax planning: Evidence from natural experiments," Journal of Corporate Finance, Elsevier, vol. 76(C).
    8. Tang, Le & Sun, Shiyu, 2022. "Fiscal incentives, financial support for agriculture, and urban-rural inequality," International Review of Financial Analysis, Elsevier, vol. 80(C).
    9. Kang, Kuan & Mohd Ashhari, Zariyawati & Dato Hj Yahya, Mohamed Hisham & Soh, Wei Ni & Li, Yue, 2024. "Interest rate liberalization and the stability of the Chinese banking system: Exploring chained mediation effects of deposit competitiveness and wealth management products," Finance Research Letters, Elsevier, vol. 62(PB).
    10. Wu, Ji & Chen, Limei & Chen, Minghua & Jeon, Bang Nam, 2020. "Diversification, efficiency and risk of banks: Evidence from emerging economies," Emerging Markets Review, Elsevier, vol. 45(C).

    More about this item

    Keywords

    Interest rate liberalization; Bank liquidity creation; Bank risk-taking; Bank balance sheet; Mediation effect; Feasible generalized least squares; G18; G21;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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