Abstract: This paper analyzes the mechanism and problems of deposit and loan pricing by commercial banks in China, tests the effectiveness of transmission of short-term market rates to lending rates, and identifies the institutional factors that weaken interest rate transmission. Our empirical results indicate that, changes in short-term market rates can influence bank lending rates, but the efficacy of transmission may be only 20%-80% of that in the US. One reason is that, due to the high volatility of short-term rates, under-development of interest rate hedging instruments, as well as the low proportion of wholesale funding and traded assets on banks’ balance sheet, most commercial banks remain reluctant to adopt market-based pricing for deposits and loans. In addition, our empirical study shows that the cap on loan-to-deposit ratio, the high reserve requirement ratio, soft budget constraints and other institutional factors may weaken interest rate transmission. Reforms to improve the interest rate transmission should include the establishing an interest rate corridor, improving the treasury bond issuance structure and the derivatives market, and further developing the CD market and asset securitization.

Full report ：WP No.20164 Monetary Policy Transmission via the Banking System.pdf