image: This Figure illustrates the trade-off between financial stability and serving firms as regulators. The arrow moving up and left represents a strategy aimed at enhancing financial stability at the expense of reducing firms ' access to credit resources. Conversely, the arrow moving downwards and right symbolizes a strategy focused on improving financial service outreach at the expense of decreased financial stability. The arrow pointing upwards and right denotes an intermediate strategy aimed at achieving an optimal balance between financial stability and serving firms.
Credit: Yi Fang，Xinman Peng.
A groundbreaking study in China Finance Review International (CFRI), “The Effect of Deregulation on Bank Risk-Taking in China: A Balance Sheet Capacity Perspective”, reveals how China’s 2009 banking deregulation reshaped risk-taking behavior among financial institutions while expanding credit access for small businesses. Existing research often overlooks how deregulation impacts bank risk-taking, but this work uncovers a pivotal trade-off: relaxed regulations boosted banks’ balance sheet capacity (via higher net interest margins), increasing risk exposure (evidenced by rising non-performing loans). However, it also enhanced long-term credit availability for SMEs in underserved regions, demonstrating financial liberalization’s dual role in supporting growth and raising systemic risks. Grounded in a 2009 quasi-natural experiment—China’s relaxation of market entry rules for joint-stock and city commercial banks—the study innovates by linking deregulation to balance sheet dynamics, offering critical insights for emerging markets striving to balance economic resilience and financial stability.
Methodology and Scope
1. Difference-in-Differences (DID) Analysis:
This study employs a DID framework, treating deregulated joint-stock and city commercial banks as the treatment group and other bank types as controls. Post-deregulation, treated banks exhibited a significant increase in non-performing loan ratios, confirming heightened risk-taking.
2. Mechanism Analysis via Three-Stage Regression:
The analysis identifies "balance sheet capacity" as the mediating channel. Deregulation boosted net interest margins, strengthening banks’ balance sheet capacity. This, in turn, increased risk appetite and contributed to elevated non-performing loans.
- Dual Impact: While deregulation raised banks’ risks, it also expanded long-term credit access for firms (especially SMEs) in historically underserved regions, broadening financial inclusion.
- Policy Trade-Off: The findings highlight a tension between enhancing credit supply to support growth and mitigating systemic risks—a critical consideration for policymakers.
Original Contributions
This study advances the literature in three key dimensions:
- Dual Perspective on Policy Outcomes: By examining both bank risk-taking and enterprise credit accessibility, it reveals a policy trade-off—deregulation strengthens financial services to the real economy but amplifies systemic risks.
- Validation of Balance Sheet Capacity Mechanism: The research empirically confirms balance sheet capacity as a transmission channel for deregulation’s effects, enriching classical theories and deepening understanding of risk dynamics.
- Bridging a Research Gap: Unlike prior work focusing on monetary or macroprudential policies, this study evaluates financial liberalization’s impact, providing actionable insights for refining regulatory frameworks.
Why It Matters
- For Policymakers: Highlights the need for balanced reforms that mitigate systemic risks while supporting SME growth.
- For Banks: Emphasizes the importance of robust risk management frameworks amid deregulatory shifts.
- For Researchers: Offers a novel lens to study financial liberalization’s dual impacts on market dynamics and institutional behavior.
Readers are welcome to download the pdf to read the full text and hope it can inspire a wide range of readers.
Journal
China Finance Review International
Method of Research
News article
Article Title
The effect of deregulation on bank risk-taking in China: a balance sheet capacity perspective
Article Publication Date
24-Feb-2025