Bank lending channel, informal finance and monetary transmission in China

This paper discusses the bank lending channel in China. Through VAR analysis, this paper finds that the bank lending channel is relevant in transmitting monetary policies: both bank loans and GDP decrease after an interest rate decrease; we also show that securities are regarded as a “buffer stock” in banks to offset monetary shocks. This paper also highlights a “puzzle”: The decreasing of bank loans cannot quickly affect real GDP. In order to explain this puzzle, from the perspective of financing channels, this paper finds that the development of informal finance in China shows an important reason to restrict the effectiveness of the credit channel in transmitting monetary policy: through a model in which informal finance is included, this paper finds that a contractionary monetary policy will reduce the threshold so that the firms with lower assets can get the informal finance to carry out their projects. The existence of a great amount of informal financing in China has reduced the ability of monetary policy to control the economy.