A Study On The Bank Capital Channel Of Monetary Policy Transmission

The evolution of monetary policy transmission mechanism has been discussed for many years and it has already forms the conceptual frameworks consists of "Money Channel" and "Credit Channel". Now the evolution is mainly driven by the changing characteristics of financial system. The changing characteristics of the financial system have recently encouraged a shift of focus in the analysis from the role of monetary controls to that of prudential controls in the transmission mechanism, especially to that of capital regulation. And concept of "bank capital channel" of monetary transmission emerged with the enhanced capital regulation.Since Van den Heuvel put forward the concept of "bank capital channel" in2002, related researches on this topic more focus on the existing reasons and the detailed acting mechanism is not clearly elucidated. The "Bank capital channel" in this thesis is under the broad credit channel framework and we define the concept of bank capital channel, and then put forward the effects of it. First, under the environment of monetary policy, banks face a constraint of "capital threshold" because breaching the minimum threshold is extremely costly for a bank. It not only means that banks need to take defensive action to limit the increasing threat of a breach, but also refers that the size of the cushion above the minimum would charged differently with its potential volatility. The minimum threshold can limit the bank’s ability to extend credit, and we define it as the "credit effect" of bank capital channel. Second, a "capital framework" constraint operates primarily through the way in which the framework influences how banks actually perceive, manage and price risks. This can happen whenever banks borrow elements from the framework in order to upgrade their own practices or to align them more closely with existing regulation. We define it as the "risk-taking" effect.On the basis of the above two effects, the monetary policy transmission asymmetry might to be amplified by the capital regulation. This is due to the ability of equity financing by banks will change in the different stages of economic cycle. In general, in the early time of expansionary monetary policy, capital constraints are binding, so the time lag of expansionary monetary policy is delayed and its effectiveness has been widely questioned. While in the economic boom, banks can easily access to capital, but the bank loans would gradually reduced by the monetary instruments including reserve ratio and interest rate. As the time passed by, the decrease of interest spread and banks’profit would reduce the value of the banks’ capital. While equity capital financing is more difficult than before, the banks’capital constraints began to work and enhance the effect of tightening policy. The asymmetry of monetary policy can be strengthened under the combined constraints of reserves and bank capital.In the recenty decades, CBRC in China has implemented regulations and contimued to strengthen the importance of capital adequacy ratio in capital supervision. At the same time, the conduction of China’s monetary policy and its effectiveness has changed. This thesis operates the research mainly based on China’s data, and is organized as follows:The first chapter presents the logical and theoretical starting point of the study; the second chapter concluds the existing literature reviews and comments; in the third chapter, this thesis confirms the role of bank credit in the monetary policy transmission and the existing of bank capital channel in China by VAR models; in the next two chapters, this thesis conducts panel-data empirical tests to verify the credit effect and risk-taking effect of bank capital channel; the sixth chapter explores the amplification of asymmetry transmission by capital regulation; the last part is conclusion.The empirical results offer possibility to treat capital adequacy requirement as an monetary policy instrument. More generally, this thesis suggests that it is necessary to take into account the role of capital regulation in the decision of monetary policy. The monetary policy by PBC and supervision policy by CBRC should be decided according to the different stages of the economic cycle. For example, in the period of economic expansion, the monetary authorities perform tightening monetary policy and regulatory authorities could enhance the effectiveness by increase capital adequacy requirement. Considering that banks have easily access to equity financing, the regulatory authorities should require a certain amount of capital buffer above the minimum requirement. By the increase of capital adequacy ratio as well as the establishment of buffer capital, macroeconomic could be less robust smoothly. Thus, when the economic turn to a period of recession, monetary policy began to shift for expansion. With the reduction of deposit reserve ratio and lending rates, the loanable funds in banking sector begin to increase and the decrease of bank capital adequacy requirement could ease the "capital threshold" constraints. Besides, the establishment of capital buffer could produce an effective "capital framework" constraint, to inhibit the rising risks in banking system under the loose monetary policy environment and to keep economic growth stable.