Interbank Liquidity Transmission and the Credit Channel of Monetary Policy in China

Abstract

This paper investigates the liquidity transmission of traditional and structural monetary policy instruments in the interbank market and their effects on bank credit growth based on 107 banks from 2005Q4 to 2020Q4 in China. We find that the credit channel of monetary policy differs across banks with heterogeneous liquidity acquisitions. The liquidity released by open market operations (OMOs) cannot stimulate credit growth,  but increases the net interbank assets of primary banks and reduces those of non-primary banks. The reduction of the required reserve ratio (RRR) increases the net interbank assets of non-primary banks and stimulates non-primary banks’ credit growth. Furthermore, an over-reliance on interbank financing mitigates the credit channel of RRR reduction among non-primary banks. In addition, medium- and small-sized banks would increase credit growth and reduce reliance on interbank financing, as the structural monetary policy instrument of medium-term lending facilities (MLFs) plays a growing role post-reform.

Keywords: Monetary policy, Liquidity transmission, Interbank behavior, Credit channel of monetary policy