Property

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WP/09/189

What Drives China’s Interbank Market?
Nathan Porter and TengTeng Xu

© 2009 International Monetary Fund

WP/09/189

IMF Working Paper Asia and Pacific Department What Drives China’s Interbank Market? Prepared by Nathan Porter and TengTeng Xu1 Authorized for distribution by Nigel Chalk September 2009

Abstract This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Interest rates in China comprise a mix of both market determined interest rates (interbank rates and bond yields), and regulated interest rates (lending and deposit rates), reflecting China’s gradual process of interest rate liberalization. We argue, using a theoretical model and empirical analysis, that the regulation of key retail interest rates diminishes the ability of the market determined rates to act as independent price signals, or as benchmarks for use in asset pricing and monetary policy. Further interest rate liberalization should, therefore, strengthen the information conveyed by movements in interest rates, allowing for the better pricing of risk and capital. JEL Classification Numbers: E43, E52, E58 and C22 Keywords: Interbank market; monetary policy; GARCH; China Author’s E-Mail Address: nporter@imf.org; tx204@cam.ac.uk

1

Asia and Pacific Department, International Monetary Fund and Cambridge University, respectively. Most of the analytical work was undertaken while TengTeng Xu was an intern at the International Monetary Fund during Summer 2008. We thank, without implication, the People’s Bank of China, Nigel Chalk, Kai Guo and Laura Papi for their helpful comments.

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References: Arora, Vivek, 2008, “China’s Financial Sector Policies,” in Innovation for Development and the Role of Government, ed. by Qimiao Fan, Li Kouqing, Douglas Zhihua Zeng, Yang Dong, and Runzhong Peng (Washington: World Bank). Bartolini, Leonardo, Guiseppe Bertola, and Alessandro Prati, 2001, “Banks’ Reserve Management, Transaction Costs, and the Timing of Federal Reserve Intervention,” Journal of Banking and Finance, Vol. 25, pp. 1287−1317 (Amsterdam, The Netherlands: Elsevier Science B.V.). –––––––, and Alessandro Prati, 2003, “Cross-Country Differences in Monetary Policy Execution and Money Market Rates’ Volatility,” FRB of New York Staff Report No. 175 (New York: Federal Reserve Bank of New York). Demirguc-Kunt, Asli, and Enrica Detragiache, 2001, “Financial Liberalization and Financial Fragility,” in Financial Liberalization, ed. by Gerard Caprio, Partick Honohan, and Joseph E. Stiglitz (Cambridge: Cambridge University Press). Engel, Robert, 2002, “Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models,” Journal of Business & Economic Statistics, Vol. 20, No. 3, pp. 339−350. (Alexandria, Virginia: American Statistical Association). Feyzioglu, Tarhan, Nathan Porter, and Elod Takats, 2009, “Interest Rate Liberalization in China,” IMF Working Paper, forthcoming (Washington: International Monetary Fund). Freixas, Xavier, and Jean-Charles Rochet, 2008, Microeconomics of Banking. (Cambridge, Massachusetts: MIT Press). Hamilton, James D., 1996, “The Daily Market for Federal Funds,” Journal of Political Economy, Vol. 104, No. 1, pp. 26−56 (Chicago, Illinois: University of Chicago Press). ICMA Centre—Business School for Financial Markets, 2005, Developing a Corporate Bond Market and Associated Derivatives Market in China: A Study of the Opportunities and Challenges (Reading: University of Reading). Koivu, Tuuli, Aaron Mehrotra, and Riikka Nuutilainen, 2008, “McCallum Rule and Chinese Monetary Policy,” BOFIT Discussion Paper 15/2008 (Helsinki: Bank of Finland, BOFIT- Institute for Economies in Transition). 30 Laurens, Bernard J., and Rodolfo Maino, 2007, “China: Strengthening Monetary Policy Implementation,” IMF Working Paper 07/14 (Washington: International Monetary Fund). Moschitz, Julius, 2004, “The Determinants of the Overnight Interest Rate in the Euro Area,” European Central Bank Working Paper No. 393 (Frankfurt: European Central Bank). Perez Quiros, Gabriel, and Hugo Rodriguez Mendizabal, 2006, “The Daily Market for Funds in Europe,” Journal of Money, Credit and Banking, Vol. 38, No. 1, pp. 91−118 (Columbus, Ohio: The Ohio State University). The People’s Bank of China, 2005, “Report on Steady Progress in Market-Based Interest Rate Reform,” Supplement to the China Monetary Policy Report, January (Beijing: The People’s Bank of China). Prati, Alessandro, Leonardo Bartolini, and Guiseppe Bertola, 2001, “The Overnight Interbank Market: Evidence from the G-7 and the Euro Zone,” FRB of New York Staff Report No. 135 (New York: Federal Reserve Bank of New York). Thruston, Thom, 2006, “China’s Money Markets: Policies and the Banks,” in China’s Financial Markets: An Insider’s Guide to How the Markets Work, Chapter 3, ed. by S. N. Neftci and M. Y. Menager-Xu (New York: Academic Press). Xu, Zheng, 2006, “China’s Money Markets,” in China’s Financial Markets: An Insider’s Guide to How the Markets Work, Chapter 2, ed. by S. N. Neftci and M. Y. Menager-Xu (New York: Academic Press).

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