Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China

Using confidential loan-level data, we examine how Basel III influenced the responses of bank risk-taking to monetary policy shocks in China. We use a difference-in-differences (DID) approach, exploiting disparities in lending behavior between high- and low-risk bank branches before and after the new regulations. Our findings reveal a novel risk-weighting channel through which monetary policy easing significantly reduced bank risk-taking. However, this risk reduction was achieved by shifting lending towards ostensibly low-risk state-owned enterprises (SOEs) with government guarantees, despite their lower average productivity. Our findings suggest a trade-off facing China’s monetary policy between curbing bank risks and addressing credit misallocation. (JEL E52, G21, G28, L32, O16, P24, P34)