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Project china

  1. 1. 1 NAME OF THE UNIVERSITY Impact of China’s Monetary Policy on ICBC and CCB Student’s Name Admission Number Course Name and Number Instructor Date
  2. 2. China’s Monetary Policy 2 TABLE OF CONTENTS CHAPTER ONE: INTRODUCTION................................................................................. 1 1.1 Chapter Overview ..................................................................................................... 1 1.2 Introduction............................................................................................................... 1 1.3 Study Background..................................................................................................... 2 1.4 Research Aims and Objectives.................................................................................. 4 1.5 Research Justification................................................................................................ 4 1.6 Chapter Summary...................................................................................................... 5 CHAPTER TWO: LITERATURE REVIEW..................................................................... 6 2.1 Chapter Overview ..................................................................................................... 6 2.2 Monetary Policy Framework in China...................................................................... 6 2.3 Monetary Policy Tools.............................................................................................. 8 2.3.1 Reserve Requirements........................................................................................ 8 2.3.2 Open Market Operation...................................................................................... 8 2.3.3 Discount Window............................................................................................... 9 2.4 China’s Monetary Policy........................................................................................... 9 2.4.1 Financial markets and Interest rates ................................................................... 9 2.4.2 Interbank Market and Monetary Policy Implementation ................................. 11
  3. 3. China’s Monetary Policy 3 2.4.3 Bank Lending and Monetary Policy Implementation by Central Bank ........... 11 2.5 The Theory of Money ............................................................................................. 12 2.5.1 Keynesian View................................................................................................ 13 2.5.2 Monetarist Point of View ................................................................................. 13 2.5.3 Implications of theorists to monetary policy .................................................... 14 2.6 Assessment of Monetary Policy in US and UK...................................................... 14 2.7 Conceptual Framework ........................................................................................... 15 2.8 Chapter Summary.................................................................................................... 16 CHAPTER THREE: RESEARCH METHODOLOGY ................................................... 17 3.1 Chapter Overview ................................................................................................... 17 3.2 Research Design...................................................................................................... 17 3.3 Data Collection........................................................................................................ 17 3.4 Data Collection Technique...................................................................................... 19 3.5 Data Analysis .......................................................................................................... 20 3.6 Limitations of the research...................................................................................... 21 3.7 Delimitation............................................................................................................. 21 3.8 Ethical Considerations............................................................................................. 22 CHAPTER 4: RESEARCH FINDINGS........................................................................... 23 4.1 Chapter Overview ................................................................................................... 23 4.2 Research Findings ................................................................................................... 23
  4. 4. China’s Monetary Policy 4 4.2.1 Relationship and Attitude of Chinese Commercial Banks towards the PBoC..... 25 4.2.2 How Chinese Monetary Policy Affects the Banking Sector in General .............. 26 4.2.3 China’s and US Monetary Policies Compared..................................................... 33 CHAPTER 5: DISCUSSION and ANALYSIS ................................................................ 37 6.0 Recommendation ........................................................................................................ 41 7.0 Conclusion .................................................................................................................. 42 References......................................................................................................................... 44
  5. 5. China’s Monetary Policy 1 CHAPTER ONE: INTRODUCTION 1.1 Chapter Overview This research chapter initiates the reader into the study conducted to establish the impact of China’s monetary policy in two commercial banks; the Industrial and Commercial Bank of China (ICBC) and the China Construction Bank (CCB). It also outlines the study background, research aim and objectives, research justification, and the chapter summary. 1.2 Introduction In response to the outbreak of the global financial crisis and the ensuing economic downturn in 2007, the Chinese government announced a stimulus package in autumn 2008 to facilitate a stable economic growth path (Geiger, 2008). Many stimulus policies and investment projects were financed through bank credit. As such, Chinese banks’ credit stock increased by 30% by the end of 2009 while compared to the previous year 2008. Frankel (2010) notes that although such pronounced economic stimulus has vast side effects, the Chinese economy responded positively through the rapid recovery of Chinese stock markets in 2009, rapid credit growth, and price increase in the real estate market. The Chinese economic performance remained steadfast with steadfast macroeconomic policies. In addition, reforms in the financial sector produced notable results as evidenced in the; development of financial markets in a steady and sound manner, efficient condition of the corporate and household sectors, progress in financial infrastructure building, and efficient functioning of the financial sector (Geiger, 2008). To prevent future economic downturn and to encourage economic reforms as well as financial sector development in China, the People’s Bank of China (PBoC) took control of the money market interest rates (Frankel, 2010). Today, the money market conditions have increasingly influenced the effectiveness of the Chinese
  6. 6. China’s Monetary Policy 2 commercial banks’ lending rates. Nonetheless, the PBoC influences the cost of credit without having any negative impact on the commercial banks’ lending rates. Koivu (2008) notes that the interests rates play an important role in determining the investment spending in China through; user cost of capital, and inflation influence through different economic activities. As such, the utility of interest rates in formulating the monetary policy promotes efficiency in the process of macroeconomic stabilization. Koivu (2008) further points out that when the flexibility of the exchange rate is increased, the exchange rate becomes more efficient in managing the macroeconomic shocks. This gives room for the PBoC to be more efficient in the process of adjusting the monetary policy to fit in the domestic macroeconomic conditions. However, Geiger (2008) asserts that any changes in the PBoC’s monetary policy should be based on informed decisions. This can only be achieved after evaluating different financial indicators and the flexible inflation objective which acts as the nominal anchor. 1.3 Study Background China’s monetary policy aims at stabilizing the currency value in order to promote economic growth (Liu & Wenlang, 2007). The People’s Bank of China (PBoC) takes the overall responsibility of formulating and implementing the monetary policy in China (Park & Sehrt, 2001). As a fact, the PBoC has a legal obligation to maintain the stability of the Chinese currency with the aim of facilitating economic growth (Park & Sehrt, 2001). According to Liu and Wenlang (2007), the PBoC was established in the year 2000 and has an eleven member committee whose main objective is to discuss and propose; the utility of monetary tools, measures of coordinating macroeconomic policies, the purpose of the monetary policy, and any adjustments to be made to the monetary policy.
  7. 7. China’s Monetary Policy 3 The Chinese financial system is highly dominated by banking institutions and more banks are continually being established regardless of the existing monetary policy. As a fact, the total assets of the entire banking sector increased by 19.7% to 52.6 trillion Renminbi (RMB) at the end of 2007 financial year (Geiger, 2008). The Chinese banks are divided into four major categories including; the government owned banks, the commercial banks, credit cooperatives, and the foreign banks (Koivu, 2008). According to Koivu (2008), the commercial banks include the state owned commercial banks (Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and China Construction Bank) and the private commercial banks (Joint-stock commercial banks, and City commercial banks). Geiger (2008) notes that in the wake of China’s monetary policy, the banking sector has improved its credit structure and continued to function soundly while implementing macro- economic policies. The balance sheet of banking institutions has expanded, with asset quality continuously improving; provision coverage ratio has further increased to a high level, and capital adequacy ratio remained stable (Geiger, 2008). According to Liu and Wenlang (2007), the fee-based income has relatively increased and loan to deposit ratio has remained stable with adequate liquidity. China’s monetary policy has spearheaded reforms in the banking institutions producing notable results; while cross-sector business and innovation have made new progress. The ICBC and the CCB are Chinese state owned commercial banks and like other commercial banks in China; their operations have also been affected by China’s monetary policy. This is evident through regulated financial markets and interest rates, coordinated interbank market operations, regulated lending, and reformed interest rates charges among other mechanisms (Liu & Wenlang, 2007). On this note, this research study seeks to establish the impact of China’s monetary policy in ICBC and CCB.
  8. 8. China’s Monetary Policy 4 1.4 Research Aims and Objectives This research study aims at determining the impact of China’s monetary policy in two commercial banks; ICBC and CCB. The achievement of this end will be guided by the following specific research objectives:  Establish the relationship between Chinese commercial banks and the Central Bank of China/People’ Bank of China  To compare China’s monetary policy with the monetary policies of other advance economies such as the US and the UK  Explore the attitudes of Chinese commercial banks towards China’s monetary policy,  Finding out how China’s monetary policy impacts on the general Chinese commercial banks. 1.5 Research Justification The decision to focus on the impact China’s monetary policy in two commercial banks, ICBC and CCB, was directly motivated by the role played by the monetary policy and the commercial banks in promoting economic growth and stability. Through the monetary policy, the PBoC controls money market interest rates and as such determining the commercial banks’ lending rates. On the other hand, ICBC and CCB provide financial services, including loans and accepting deposits, with the aim of generating income from the interests charged on these financial services (Liu & Wenlang, 2007). Interest rates in the republic of China determine the investment spending through cost of capital and overall economic activity (Koivu, 2008). As such, controlling the interest rates charged by the commercial banks will have a direct impact on the investment spending as well as on the overall economic activities in China.
  9. 9. China’s Monetary Policy 5 With the significant role played by ICBC and CCB in providing capital to the Chinese investors, this study will go a long way in establishing how the activities, services, and performance of the ICBC and CCB are affected by the monetary policy. It will also promote the establishment of efficient mechanisms of managing the impacts of monetary policy in ICBC and CCB. All these will enable ICBC and CCB to operate efficiently under the monetary policy guidelines and achieve their goal of value addition while at the same time promoting local investment through provision of financial services to their customers. 1.6 Chapter Summary This chapter provided an introduction to the exploration of the impact of China’s monetary policy in two commercial banks; ICBC and CCB. The PBoC controls the money market rates with the aim of promoting economic stability. On the other hand, the commercial banks provide financial services to generate income from the interests charged on these services. This study will therefore provide an effective scenario whereby commercial banks achieve their core objectives while operating within the guidelines of the monetary policy thus promoting economic growth and stability.
  10. 10. China’s Monetary Policy 6 CHAPTER TWO: LITERATURE REVIEW 2.1 Chapter Overview This chapter presents a synthesis of scholarly and peer reviewed literature/theoretical framework on the impact of China’s monetary policy in ICBC and CBB. It provides evidence on the past studies conducted on the impact of China’s monetary policy on the Chinese commercial banks. 2.2 Monetary Policy Framework in China In the process of achieving the aims and objectives of the monetary policy, the People’s Bank of China (PBoC) is currently employing a combination of both standard and nonstandard monetary policy instruments (Braun & K’orber, 2011). According to Chen et al. (2009), the PBoC employs a three font control mechanism to ensure success of the monetary policy. To begin with, the PBoC implements measures of ensuring that the Chinese commercial banks operate within tight limits. This, according to Chen et al. (2009), has been achieved through imposing regulations on the loan rates as well as the deposit rates charged by these banks to their customers. Second, Chen et al. (2009) observe that the PBoC utilizes non-market policies, like window guidance and loan quotas, in a process in which they dictate the manner in which the Chinese commercial banks conduct their business. In this vein, Chang et al. (2012) hold the opinion that the window guidance has been highly effective in influencing the direction of the commercial banks lending. In this process, China’s quantitative credit quotas become highly significant in the process of controlling the amount of credit (Chen et al., 2009). The PBoC controls the required reserve ratio in the process of promoting the success of the monetary policy. According to Chen et al. (2009), this policy has not been used as a monetary control tool by many western type central banks in the past; nonetheless, this policy
  11. 11. China’s Monetary Policy 7 has contributed significantly in the successful control of China’s monetary policy. China’s monetary policy has been efficient in promoting the stability of the Chinese currency and the economy at large (Braun & K’orber, 2011). However, He and Wang (2012) affirm that reform initiatives and proposals are already in place to ensure the transformation of the Chinese financial market into a more liberal financial market characterized by market based monetary policy structure. According to He and Wang (2012), the proposed reform initiatives and proposals include; the establishment of an over the counter (OTC) equity market aimed at financing the business activities of the high tech small and medium enterprises, establishment of a high yield bond market for the Chinese small and medium enterprises, creation of pooled debt instrument through jointly issued notes, expanding the existing interest rate benchmark to enable the local commercial banks to adjust their lending rates from 10% to 20% below the official benchmark, mechanisms of enabling commercial banks to convert loans into securities and as such increase the available lending pool, establishment of wealth management products in place of the traditional bank deposits and as such provide bank customers with increased returns, and promote mechanisms of enabling the private financial lenders to operate as investment firms and offer financial services to large companies. According to Chang et al. (2012), the Chinese financial system is still underdeveloped and more oriented towards the banking institutions in the face of the identified financial reforms. Zhang and Wu (2012) add that there also exists an imbalance in the Chinese capital markets due to the underdevelopment of the Chinese corporate bond market. Although many of the identified policy initiatives and proposals are aimed towards promoting reforms in the financial market, some of them will be highly efficient in developing the Chinese corporate bond market (He &
  12. 12. China’s Monetary Policy 8 Wang, 2012). In the current financial market situation, Braun and K’orber (2011) opine that the Chinese commercial banks are offering skewed interest rates as tax representation on depositors and industry subsidy. Nonetheless, monetary policy regulates the interest rates to minimize consumption and as such favour increased investment. To this end, Chang et al. (2012) affirm that the establishment of a liberal financial system would promote productive investment through regulated interest charges on commercial bank loans. 2.3 Monetary Policy Tools 2.3.1 Reserve Requirements In 1984, the PBoC introduced the reserve requirement with the aim of controlling the liquidity in the financial sector. Initially, different reserve obligations were set for the different deposits in line with their origin as well as the banking institution that is holding the reserves (Gerlach & Kong, 2005). According to Gerlach and Peng (2006), the PBoC later combined all the reserve requirements in the year 1985 and established one minimum reserve requirement at 10%. In 1998, Gilchrist and Zakrajsek (2007) point out that the PBoC started to actively engage the reserve requirement as a tool for monetary policy and altered its monetary policy from direct to indirect control where open market operations became the major tool for monetary policy control. 2.3.2 Open Market Operation Open market operation was introduced by the PBoC as a tool for monetary policy control in the year 1993. Nonetheless, the absence of the interbank market in PBoC institutional foundation made the utility of open market operation relatively challenging at that point in time. As such, only relatively few open market operations were conducted in the following years (Ma & McCauley, 2007). According to Gilchrist and Zakrajsek (2007), the utility of open market
  13. 13. China’s Monetary Policy 9 operation was halted in 1997 by the PBoC but later introduced back in 1998 when the institutional foundation was better and more advanced. According to McKinnon and Schnabl (2009), the open market operations aim at controlling the short term interest rate and the supply of base money in an economy, and thus indirectly controlling the total money supply. The open market operations include; national bonds, bills of the central bank, and the financial bonds from other recognized financial institutions. 2.3.3 Discount Window This monetary policy control tool, as noted by Chang et al. (2012) was adopted in China in the year 1998 and was coined in line with the Japanese system that had been in existence for over 40 years before it was abolished in 1990. Through this policy tool, Braun and K’orber (2011) opine that the discount window is an instrument of monetary policy that makes it possible for eligible banks or financial institutions to access money from the central bank, on a short term basis so as to bridge gaps in liquidity due to various reasons. According to Zhang and Wu (2012), the window guidance policy enables the PBoC to influence the operations of the banking and financial institutions as the money borrowed is charged a different interest rate from the existing market rate and banks have to indicate the amount of money out of the total borrowed they wish to loan out. 2.4 China’s Monetary Policy 2.4.1 Financial markets and Interest rates In the republic of China, the interbank market for bonds has been operational and in rapid development from 1997 (Gerali et al., 2010). The rapid growth, according to Gerali et al. (2010), is attributed to the effectiveness of China’s monetary in the liberalization of the financial sector and the market infrastructure. This has in turn facilitated the establishment of an effective
  14. 14. China’s Monetary Policy 10 financial infrastructure that promotes a highly elaborate lending and borrowing structure in the Chinese commercial banks. Hsieh and Klenow (2009) observe that the monetary policy has ensured that commercial banks increasingly offer bonds of longer maturity in addition to ensuring a rapid growth of turnover and liquidity. According to Chen et al. (2009), the Chinese government has offered relatively few bonds forcing the PBoC to increase its bond offering in the financial market. Due to regulations by the National Development Reform Commission, there has been under-development in the Chinese corporate paper market until the year 2004. However, the PBoC a corporate commercial paper market in 2007 and facilitated medium-term corporate notes to be traded in the financial market (Hsieh & Klenow, 2009). This facilitated more than tripling of the outstanding stock of commercial paper and bonds that had been provided by the non-financial corporate sector as well as the local government between 2007 and 2009. According to Chen et al. (2009), the net sales totalled to 4% of the gross domestic product in 2009 and the rate of borrowing by the local governments and non-financial sector reduced resulting to a reduction of outstanding stock debt to 9% of annual GDP. Braun and K’orber (2011) note that there are different money markets in the republic of china. The market for uncollateralized loan is relatively small and is run between banking institutions. 90% of the short term money market turnover uses bonds as well as collateral in the repurchase market. The repo market facilitates the trading of loans on the stock exchange as well as between banking institutions. The inter-bank repo market, on the other hand, financial trading follows the 7 day maturity accounting for almost 80% of the total turnover (Braun & K’orber, 2011). As noted by Zheng et al. (2012), the interest rates offered in the short term market include the Chibor and the Shibor. Through China’s monetary policy, the interbank rates, bond yields and the bill discounting rates are liberalized with the aim of clearing the market and facilitate
  15. 15. China’s Monetary Policy 11 borrowing and lending by the commercial banks. Nonetheless, the corporate bill market regulates the minimum rates at which new issues can be made (Zheng et al., 2012). 2.4.2 Interbank Market and Monetary Policy Implementation In the year 2003, Chen et al. (2009) assert that all the repurchase agreements were converted to Central Bank bills by the PBoC with the aim of establishing an intervention mechanism in the money markets. To attain its targets on liquidity, the central bank performs open market operations using the existing PBoC bills of different maturities. In 2004, PBoC established the following mechanisms to improve its open market operations; establishing one and three year tenors, increasing the frequency of open market operations auctions, expanding the trading periods, and connecting the bill trading system to the payment system to ensure a pay on delivery system (Braun & K’orber, 2011). Chang et al. (2012) opine that although fixed interest rates are used sometimes, bill auctions are handled as fixed quantity tenders with a varying interest rate as stipulated by quantity based measures in the implementation of the monetary policy. According to He and Wang (2012), the PBoC controls short term money market interest rates. In the same vein, PBoC controls the interbank market through regulating the interests it pays on the excess reserves. In an effort to encourage the development of the interbank market, Chang et al. (2012) observe that the PBoC increases the spread between the interest rates charge on excess reserves and the base lending. As a result, the market interest rates have continually had a strong influence on the rates in the interbank market. 2.4.3 Bank Lending and Monetary Policy Implementation by Central Bank It has been established clearly by different scholars (Chang et al., 2012; Braun & K’orber, 2011; Zhang & Wu, 2012; Zheng et al., 2012) that PBoC regulates market rates through
  16. 16. China’s Monetary Policy 12 open market operations. However, He and Wang (2012) hold the view that the major channel for PBoC’s interest rate policy is through regulation of bank deposit and lending rates. From the early 1990s to the beginning of 21st century, the PBoC has continually expanded the margin between lending and deposit rates from zero to 350 basis points. This has been highly effective in promoting a scenario in which banking institutions are perceived as entities that have the right to earn a rate of return on their own capital (Zhang & Wu, 2012). Braun and K’orber (2011) asset that except in 2005 and 2009 when the repo rates were relatively low, the PBoC has regulated the lending rates in line with the repo rate from the year 2002. In 2005 and 2009, Braun and K’orber (2011) affirm that the PBoC ensured that the regulated lending and deposit rates did not fall in line with the current market rates. In 2006 and 2007, the PBoC increased the saving rates while there were no effected changes in the policy of holding regulated rates above market rates during the 2009 economic downturn. Such financial changes have become difficult to manage due to the growth of the commercial paper market. For instance, the issuance of commercial paper surged in 2009 as a result of different companies changing their borrowing from the banking institutions to commercial paper market where interests were relatively low (Gerali et al., 2010). 2.5 The Theory of Money The theory of money provides a scientific explanation in the field of economics on the existing relationship between market or policy decisions and money. In the theory of money, Michel (1996) holds the opinion that money is regarded as the accepted and preferred medium of exchange in the market. As noted by Marcuzzo (2001), the existing theories of money are highly complex and vary from one school of thought to the other. In macroeconomics, Michel (1996) observes that the theories of money are applied in both private and public policy decision making
  17. 17. China’s Monetary Policy 13 processes with the aim of producing the expected economic outcomes such as economic growth and stable prices of goods and services. 2.5.1 Keynesian View The Keynesian theory of money is supported by the followers of John Maynard Keynes; an economist who is widely recognized for proposing alternatives to the classical economic theories. In line with the Keynesian view, Mata (2004) affirms that the economy is categorized into two; the real economy and the monetary economy. The real economy is built on the factors of material production like labour while the monetary economy influences the factors of valuation such as prices of goods and services. Along the lines of monetary policy and financial regulation, Minsky (1993) affirms that the Keynesian view supposes that different events in the real economy, for instance reduced labour demands and regulation policies, have a greater influence on the economic growth and stability as compared to the economic events that only affect the supply of money. 2.5.2 Monetarist Point of View As noted by Michel (1996), the monetarists are followers of Milton Friedman and are interested in the effects that policies have on the economy in terms of the size as well as the structure of money supply. In this view, the monetarists are concerned with issues of price levels, the availability of credit as well as the value of the currency. Mata (2004) shares the opinion of Minsky (1993) that the monetarists are believers of the fact that the events that directly affect the amount of money available in the economy have greater influence on the short term productivity while compared to other factors such as government policies as well as employment levels.
  18. 18. China’s Monetary Policy 14 2.5.3 Implications of theorists to monetary policy According to Mata (2004), the monetarists and the Keynesian theories of money can be related to the issues surrounding the monetary policy and financial regulation. In this case, the Keynesian economists address the conditions of weak economy through fiscal government stimulus. This would include reduced taxation, increased measures of investment in long term productive output, and increase in the expenditure of the government with the aim of raising the economic demand (Mata, 2004). On the other hand, the monetarists increase the supply of money that is available to businesses and financial institutions with the aim of promoting access to credit and thus generate productive growth (Marcuzzo, 2001). Different governments and central banks implement policies that are in some point related to these theories when responding to economic recessions (Mata, 2004; Marcuzzo, 2001; Minsky, 1993). 2.6 Assessment of Monetary Policy in US and UK Gordon and Leeper (1994) observe that the Federal Reserve controls the monetary policy in the United States of America. The Federal Reserve controls the monetary policy of the US through financial and economic activities that influence short term interest rates. According to Frenkel et al. (2005), money supply in the US is broken down into different categories that reflect on the different levels of liquidity in each category. Equally, the broader forms of money can be easily converted to other forms of money depending on the acceptability in different financial institutions. According to Frenkel et al. (2005), the Federal Reserve utilizes three main mechanisms of controlling the monetary policy including; trading treasury securities to reduce the monetary base, changing the discount rate, and infrequent adjusting the reserve requirement to influence the money multiplier. Nonetheless, the Federal Reserve utilizes the open monetary operation to regulate short term interest rates as the major tool of monetary policy in US.
  19. 19. China’s Monetary Policy 15 According to Fatum and Hutchison (2003), monetary policy in the United Kingdom (UK) entails the utility of the existing interest rates in collaboration with other different monetary tools to regulate the level of consumer spending and aggregate demand. Faust and Rogers (2003) note that in UK, the monetary policy aims at maintaining the inflation within a target of 2% plus or minus 1. Nonetheless, other macroeconomic variables including growth and unemployment are also put into consideration while implementing monetary policy regulations. As noted by Fatum and Hutchison (2003), the Monetary Policy committee (MPC) of the Bank of England sets the UK monetary policy. This is done independently though with the aim of meeting with the government’s inflation targets. The major monetary tool used by the MPC in UK is quantitative easing which involves the electronic creation of money to facilitate the purchase of different assets to increase money supply and avoid the effects of deflation (Faust & Rogers, 2003). 2.7 Conceptual Framework The main connection between China’s monetary policy and commercial banks, ICBC and CCB, is in the regulation of the lending and deposit rates by the PBoC in an attempt to stabilize the Chinese economy and the Chinese currency. Through the use of monetary tools (open market operations, discount window, and reserve requirements), the PBoC ensures that the commercial banks operate in line with the government’s inflation targets while at the same time adding their own value through interests gained through deposits, loans and other financial services. Nonetheless, there is need to transform the Chinese financial market into a more liberal financial market characterized by market based monetary policy structure.
  20. 20. China’s Monetary Policy 16 2.8 Chapter Summary This chapter presented a review of the existing scholarly literature to establish the impact of China’s monetary policy in ICBC and CCB commercial banks. China’s monetary policy was established to play a huge role in promoting; investment, economic growth and stability, and the stability of the Chinese currency through regulating the lending and deposit interests charged by commercial banks. Keynesian and monetarists views were established to have a direct relation with mechanisms of managing economic recession. China’s Monetary Policy Reserve Requirement Affects the banks’ funds available for loans Discount Window Allows banks to borrow money from the PBoC on a short term basis Open Market Operation Influences the short term interest rates and supply of base money Impacts in Commercial Banks Expansion of financial markets and regulated interest rates Control of interbank market through regulated interests on excess reserves Regulation of lending rates in line with repo rates
  21. 21. China’s Monetary Policy 17 CHAPTER THREE: RESEARCH METHODOLOGY 3.1 Chapter Overview The focus of this chapter is on the methodologies employed in exploring the impact of China’s monetary policy on the two selected banks; Industrial and Commercial Bank of China (ICBC) and China Construction Bank (CCB). The formulation of these research methodologies was based on the research questions to ensure yield of reliable data. The research activities undertaken including the research procedure and design and the limitations of the study are all discussed in detail in this chapter. 3.2 Research Design A secondary research approach was employed. As guided by Fisher (2004), this approach involved collection of data from existing theories and literature on the impacts of China’s monetary policy on ICBC and CCB. The selection of secondary approach was based on its time saving ability compared to primary research. Moreover, secondary research has fewer constraints to data collection as compared to primary research (Bryman, 2001). By using secondary research, it was very easy to obtain information from peer reviewed materials and literature on the relationship between the China’s commercial bank and the central bank. However, this approach had limitations in that the materials collected could not extensively reveal the situation at hand since it was very hard to exhaustively determine the attitudes the commercial banks’ strategists have on China’s monetary policy. 3.3 Data Collection According to Saunders et al (2007), the process of data collection is the most significant and the ultimate research procedure during any research study. In line with this, caution was highly observed in the data collection process to ensure that only the valid and highly reliable
  22. 22. China’s Monetary Policy 18 information was gathered to understand the actual impacts of the monetary policy in China on commercial banks. The sources earmarked for data collection included journal publications on China’s monetary policy and its comparison to those of the USA and UK, articles such as banking newsletters provided by several research and auditing institutions such as Price Waterhouse Coopers ( PWC), annual data reports in Chinese banks and their performance, and China’s Monetary Policy Reports formed the basis for collecting information. Government Statistics on the relationships of the commercial banks to the Central Bank, websites of commercial banks in China and archived materials from financial libraries on overall impacts of the China’s monetary policy on the Chinese commercial banks in general provided basis for information on the relationship between the peoples bank of china and other commercial banks. Performance of the CCB and ICBC over the past years was also analysed from information collected from the websites of China’s stock exchange market. This was used to compare the growth over the past years with the monetary policies implemented to help ascertain the effect of monetary policies on the Banks’ performance. Selected excerpts from press on China’s monetary policies by college professors, research analysts the governments and the monetary policy committee also formed the basis for information. Journals by the Association of Industrial and Commercial Banks in China, will be collected and analysed to provide information on the attitudes of the commercials banks on China’s Monetary Policy. These records were targeted because the information they contained was factual and realistic based on reliable and credible studies. Information on ICBC and CCB was obtained
  23. 23. China’s Monetary Policy 19 from the websites of the two banks as well as the annual reports which were easy to access. Moreover, information on the banking industry in China was used to further the understanding of the general impacts of the monetary policy in China on the banks. Government information on banking in China was effective in revealing the roles and functions played by the central bank and the information on global banking. This research ensured that the sources used had updated information and that they were not more than a decade old. The impacts of the monetary policy in China vary with time as the economic status is transformed and thus the need for using up to date information in the research. The information that was collected physically from the premises of the banks was achieved after approval from the persons in charge of those facilities. 3.4 Data Collection Technique This study utilized qualitative approach to data collection because the research aimed at achieving a holistic understanding of the impacts that the monetary policies in China had on the commercial banks in the country. The use of qualitative research design promoted an efficient review of the existing secondary information on the impacts of China’s monetary policy on the commercial banks and the attitudes that the banks had on the policy. The materials used for this purpose were carefully selected from peer-reviewed sources and authenticated platforms that had updated materials on the banking industry in China as well as in the United Kingdom and USA. Qualitative approach is cheaper than quantitative because it only focuses on a small group (respondents) targeted (Saunders et al, 2007). The focus of the study was only on the banking industry in China with a brief overview of Banking in the UK and USA. Records from the sources collected were retrieved from historical data records although with a specified period span. Historical information dimension was utilized in the qualitative approach because past
  24. 24. China’s Monetary Policy 20 information was instrumental and key in understanding the impacts of China’s monetary policy on the commercial banks. Obtaining reliable secondary information on the attitudes of the commercial banks in China on China’s monetary policy was very tricky and this was a major drawback to the data collection technique. 3.5 Data Analysis This study collected qualitative as well as quantitative data as a result of the use of secondary approach. This qualitative data was analyzed using descriptive and interpretive approaches to give meaning and evaluations (Saunders et al, 2009). The use of descriptive and interpretive processes in analyzing the research data qualitatively made the data more meaningful and illustrative in the process of establishing the impacts of China’s monetary policy on the performance of CCB and ICBC. The quantitative data was analysed to provide graphs for clear understanding of the qualitative conclusions. On the same note, all the data collected was summarized and expounded in line with the research objectives to ensure that the research main findings were understood clearly. Firstly, the information collected was segmented into number of years so as to get correct information on the relationship between the People’s Bank of China and the commercial banks. Similarly, information concerning ICBC and CCB was scrutinized to ensure that the annual reports had analysis focusing on the effects exerted by the monetary policy as well as the attitudes and sentiments of the banks on the policy. The validity and credentials of the authors of peer reviewed journals and publications were counterchecked to eliminate invalid and authors who are not credible. This was done through checking on the name of the author/source on academic list of approved authors discussing on the banking industry in China and the UK as well as the USA. To ensure the information collected from the sources was valid and reliable, the study counterchecked on the
  25. 25. China’s Monetary Policy 21 usage of the materials on discussing the monetary policy of China by accredited institutions and bodies such as universities and government entities. After the data collected was filtered and only relevant materials identified, the objectives were clearly reinstated to ensure effective analysis of the findings. Data collection and analysis focused on the following elements: (1) the relationship between Chinese commercial banks and the Central Bank of China/People’ Bank of China, (2) comparison of China’s monetary policy with the monetary policies of developed and advanced countries like the USA, (3) an exploration of the attitudes of Chinese commercial banks on China’s monetary policy, and (4) determining the impacts of China’s monetary policy on the commercial banks in China. 3.6 Limitations of the research This study had a major drawback that emanated from the fact that most of the information available was incomplete. A good number of the sources provided only a portion of their research findings for free and charged costly fees to access the full copies of their research findings. Furthermore, obtaining reliable and accurate information on the attitudes of the commercial banks towards China’s monetary policy was difficult. 3.7 Delimitation To overcome the above limitations this research paper, limited itself to secondary sources that exclusively addressed the topic on the impact of monetary policy on ICBC and CCB. To this end the sources were subject to a vigorous selection process to ensure relevant sources were used in this study.
  26. 26. China’s Monetary Policy 22 3.8 Ethical Considerations Schicktanz and Dusche (2011) share the opinion of Gillham (2000) that ethical considerations are related to rules and regulations and they do not challenge any research procedures. This study considered the nature of consent required to facilitate ethical utility of the available secondary data in answering the research questions. In some cases, the personal information of the initial research respondents had been used in the available data; their consent was sought before re-utilizing their information in this study. Equally, some researchers had provided their contact details on their secondary research materials and as such, it was relatively easy to seek their consent before utilizing their findings in this study.
  27. 27. China’s Monetary Policy 23 CHAPTER 4: RESEARCH FINDINGS 4.1 Chapter Overview This chapter focuses on presenting the results that were obtained during data collection and research. The research focused on establishing the impacts of China’s monetary policy in two commercial banks, namely the Industrial and Commercial Bank of China (ICBC) and the China Construction Bank (CCB) which are Chinese Commercial Banks 4.2 Research Findings As posited by Braun and K’orber (2011) the duty of establishing the monetary policy in China falls under the Jurisdiction of the People’s Bank of China (PBoC) and it utilizes both standard and nonstandard monetary policy instruments. To see to it that the monetary policy adopted by PBoC actually works, Chen et al. (2009) posits that PBoC employs a three font control mechanism namely ensuring that banks operate within tight limits, application of non- market policies such as window guidance and loan quotas and lastly it controls the required reserve ratio. Chen et al. (2009) opine that measures such as window guidance has been very effective in influencing the direction of commercial banks such as ICBC and CCB where this policy influences how these banks conduct their lending activities to individuals as well as banks, as such it is clearly evident that the monetary policies fronted by the PBoC has had a major influence on how commercial banks operate in China. Monetary policies are broad in nature and constitute various sub sections or instruments that the PBoC has utilised to influence or dictate how commercial banks in China carryout their business. As posited by Chen et al. (2009) the PBoC control of the required reserve ratio has helped promote the success of the monetary policy. Controlling the reserve ratio that banks
  28. 28. China’s Monetary Policy 24 should hold aids the PBoC attempt to control the amount of money in circulation in the economy, which helps keep inflation and interest rates at manageable levels. He and Wang (2012) indicate that there are various reform initiatives underway in the Chinese financial sector that are expected to modernise and liberalise the financial market characterised by market based monetary policy structure. To this end it is expected that the PBoC influence on commercial banks will continue but adopt strategies that are widely practised in various parts of the world such as the US and EU. These envisaged changes in the monetary policy framework will go a long way in ensuring the PBoC continues to influence the banking sector using modern and widely used policies around the world. Citing the proposed reforms He and Wang (2012) opine that there is a proposed establishment of an over the counter (OTC) equity market aimed at offering credit to high tech small and medium enterprises, establishment of a high yield bond market for Chinese SME’s, creation of pooled debt instrument trough jointly issued notes, and expanding the current interest rate benchmark enabling commercial banks adjust their lending rates from 10% to 20% below the official benchmark. This significantly highlights the influence of the PBoC on the banking sector in China. While it is expected that the PBoC will carry out these changes banks such as ICBC and CCB are expected to put these changes into practise when they are sanctioned by the PBoC, which is in charge of the monetary policy in China. Braun and K’orber (2011) observed that in the current financial climate Chinese commercial banks have been witnessed as offering skewed interest rates as tax representation on depositors and industry subsidy, but monetary policy instituted by the PBoC regulates the interest rates in order to minimise consumption in the process favouring investment. As such the establishment of a liberal financial system as opined by Chang et al. (2012) would enhance
  29. 29. China’s Monetary Policy 25 investment by ensuring that commercial banks charge interest rates in line with the guidelines of the monetary policy put forth by the PBoC. 4.2.1 Relationship and Attitude of Chinese Commercial Banks towards the PBoC According to Dickinson and Jia (2007), the majority of Chinese banks are in agreement with the pivotal role that the PBoC plays in offering regulation in the industry, the minority who do not wholly side with the PBoC argue that there is need to treat all banks as equals regardless of whether they are wholly owned by the government, private or their size in terms of reach and value in terms of deposits, and asset value. Dickinson and Jia (2007) further posit that when the PBoC in early 2006 announced there will be major reforms in the financial sector players in the industry anticipated a level playing field and a modernisation of the financial system to align it with those of major economies such as the US and the UK. Although there have been steps in reforming the financial sector, the issue of equality still needs to be addressed as the PBoC has been accused time and again of skewing the monetary policy towards the interests of government owned banks. From the latest journal from Association of Industrial and Commercial Banks (2012), the Banks, however feel that the PBoC is not competent enough since the China’s currency (Renminbi) cannot account for even 3-5% of the worlds reserve by 2020. 2.6% of the commercial banks in China have faith that the PBoC is competent enough to lead the currency to a better reserve share by 2020. The main reason for the low count is because the PBoC have failed to curb the shadow market that according to the Association of Industrial and Commercial bankers is currently at 11%. According to Dickinson and Jia (2007), after the economic crisis of 2008 the PBoC agreed to institute major reforms that would make the financial sector a level playing field, key
  30. 30. China’s Monetary Policy 26 among the reforms proposed by players in the sector include, improvement of the RMB exchange rate formation regime where market demand and supply will be given precedence, advancing market based interest reform, reforming state-owned commercial banks and rural credit cooperatives where they ought to be modernised, be governed under the same rules such as amount of capital, strict internal control among others. in addition, players in the private sector are angling for more financial market development key among them being the neutrality of the PBoC in coming up with the monetary policy. In a nutshell, the relationship between the PBoC and majority of privately owned commercial banks is far from ideal with one side pushing for reforms that will create a level playing field with government owned commercial banks. In addition, it is important to note that there exist a relationship of mutual respect between the PBoC and commercial banks as the latter recognises the former role as a regulator of the industry through monetary policy interventions. 4.2.2 How Chinese Monetary Policy Affects the Banking Sector in General More restrictive monetary policy was noted in china in 2010 after a 50% hike in the prices of houses due to high interest rates by the ICBC and the CCB. The market prices of houses rose from 24% to 42% in 2010. According to Dyer and Waldmeir (2010) this forced the government to shift its monetary policy from being “appropriately loose” to being more “prudent”. According to Yao, (2011) by February 2011, the bank reserves ratio had risen eight times to 19.5% while bank deposit rate rose from 3% to 6.06%. The PBoC is the custodian of monetary policy in China and whatever actions or declaration are contained in the policy it is bound to influence how commercial banks such as ICBC and CCB carryout their operations. To this end, as posited by Braun and K’orber (2011) the PBoC has instituted various monetary policy tools to regulate and control the banking sector
  31. 31. China’s Monetary Policy 27 in China. According to Gerlach and Kong (2005) in 1984, the PBoC introduced the reserve requirement with the purpose of controlling liquidity in the economy at large. To this end Gilchrist and Zakrajsek (2007) posit that in 1998 the PBoC utilised the reserve policy actively and altered its monetary policy from direct to indirect control. This scenario implies that the PBoC influences the amount of reserves both the ICBC and CCB can hold which is set at 10% of the total reserves with the remaining 90% expected to be under the custody of the PBoC. As such, this monetary tool by the PBoC effectively influences the lending policy of both ICBC and CCB as the amount they actively hold is determined to a large extent by the reserves policy dictated through the monetary policy. As such, the need to maintain the ideal amount of money in circulation in order to contain inflationary pressures brought about by too much money chasing little goods and services or the vice versa. To mop up excess liquidity the PBoC through the reserve requirement tool may opt to sell various financial instruments such as bonds, commercial papers among others, while if there is need to increase the amount of money in circulation the PBoC may buy bonds among others. In 2001, PBoc decreased its reserve ratio to 8% which increased the commercial banks reserves and in turn led increased lending to the general public. Subsequently, this move stimulated investment as the public could access credit at lower interest rates. According to Annual reports of ..... ICBC credit lending increased by over 40% to 4.3 Billion Renmbi. Transmission mechanism approach can be used to support this hypothesis. McKinnon and Schnabl (2009) allude that the open market operation is aimed at controlling the short term interest rate and the supply base of money in an economy, in the process dictating the amount of money supplied. To this end, it is clear that the monetary policy
  32. 32. China’s Monetary Policy 28 focussing on open market operations instituted by the PBoC affects ICBC and CCB in various ways, namely it determines short term interest rates that these banks can charge on loans, and the amount of money available to these banks. As such the influence of monetary policy adopted by the PBoC can be seen to impact largely the operations or the capacity of both ICBC and CCB and largely the banking sector in China. As evident there exist a relationship between the monetary policy and the operation of both ICBC and CCB and this relationship can be viewed in terms of regulatory role played by the PBoC through various monetary policy instruments such as the open market operation. As argued by Braun and K’orber (2011) through this policy tool, the PBoC allows banks such as ICBC and CCB to access loans on a short term basis to cover any short falls in liquidity due to various reasons. To this end there is a provision for discount window lending where banks access loans directly from the PBoC though there are various conditions such that if either the ICBC or CCB uses this discount lending window, the interest rate charged is usually lower than the existing rate in the market, as such the banks can be able to lend out the money at lower rates than what is in the market in the process benefiting from interest income from loans as more businesses as well as individuals will borrow more. In addition, if the ICBC or CCB opts to use this monetary policy, the PBoC sets a limit of the amount that can be loaned out in the process limiting the amount of interest income that can be earned from the total amount borrowed. As further argued by Braun and K’orber (2011) through this monetary policy the PBoC influences or impacts the operation of ICBC and CCB in terms of the interest rate to be charged and the amount of money available to be loaned out. From 1998 to 2009, for example, there was a maximum be3nchmarke interest rate for the market that was imposed by the PBoC as shown in figure 2 below. It is clear from the analysis of
  33. 33. China’s Monetary Policy 29 the above figure that the interest rate charged by the PBoC is normally lower to allow the banks to earn some profit on their interest rates. Figure 2: Benchmarked interest rates by the PBoC. Source: People’s Bank of China These restriction of interest rates by the PBoC eventually affected credit offered by ICBC and CCB to several sectors in China. The housing sector was the worst affected by the change in interest rates as a result of restrictions by the PBoC that eventually affected growth in home price of the housing sector. Figure 3 below shows the effect of interest rates on growth of the housing sector.
  34. 34. China’s Monetary Policy 30 Figure 3 Growth in home price and credit to the housing sector (annual Data 1998-2009) Source: “Report on China’s Real Estate Finance,” 2004, 2006, 2008, by the Analytical Team Of Real EstateFinance , Peoples Bank of China, China Financial Publishing House. The impact of Chinese monetary policy on the banking sector or the financial sector can be viewed as being of a regulatory nature and in some cases a symbiotic relationship. As evident from the discussion on the three monetary policies employed by the PBoC (discount window, open market operation and reserve requirement) have a major impact on how banks in China
  35. 35. China’s Monetary Policy 31 carryout their operations, there are other monetary policy tools that influence how banks in China operate or are impacted by the regulations imposed by the PBoC. Dobson and Kashyap (2006) China’s eccentric take on moneatry policy with three observable particularities that impact heavily on the chinese banking sector, namely Chinese banks run their operations under tight limits where the PBoC imposes a floor on rates charged on loans as well as interest earned on deposits. Second, the use of non-market tools such as loan quotas and window guidance is rampant, which can be related to telling banks how to carryout their duties, third the reserve ratio rarely applied in the west is a cornerstone of the Chinese monetary policy mostly applied in short term basis. On the other hand Forssback and Oxelheim (2007) allude to an unique monitory policy reffered to as Specific central bank lending scheme that through provided eligibility requiremenst, the PBoC makes funds available for a given sector suchc as the banking sector at a lower cost. This has the impact of making cheaper credit availble from banks that in the long run translates into higher interest income from loans. As evident, the impact of Chinese monetary policy on the banking sector is more regulatory in nature and the PBoC can be viewed as the regulatory arm in this relationship. Looking at the overall monetary transmission mechanism in China, it has the same functions or goals as that of the U.S that’s to influecne or control inflation and promote overall economic growth. The tools used by the PBoC as posited by Green (2005) impact or influence the banking sector by varying the overnight interest rates at which banks lend to each other where the higher the rate the more money is held in banks rather than being lent out. Other monetary policies that encompass the monetary transmission mechanism include the reserve
  36. 36. China’s Monetary Policy 32 requirement where different banks are classified according to tiers with second tier banks that are deemed to be less sound having higher reserve requirements that 1st tier banks. This creates a regulatory relationship between the PBoC and the commercial banks and other financial instituitions. The overall effect of monetary policy on an economy in general is the monetary transmission mechanism which prroceed through impulses or links known as the transmission channel. The summary on the transmission channels is shown in figure 1 below. Figure1: Transmission channels of the effect of monetary policy Source: Thompson DataStream Through these policies introduced by the PBoC, commercial banks such as the ICBC and CCB have been able to establish an effective financial structure that has gone a long way to promote a highly elaborate borrowing and lending structure in the financial and banking sector. As evident from the issuance of commercial papers by the PBoC it had the effect of lowering the
  37. 37. China’s Monetary Policy 33 interest rate charged by banks on loans further evidence that monetary policy impacts the operations of banks such as ICBC and CCB. 4.2.3 China’s and US Monetary Policies Compared According to Forssback and Oxelheim (2007) the PBoC and the Federal Reserve Bank of the United States mandates do not differ as they are both mandated to come up with policies that would promote economic growth, and tighten monetary policy in order to tame inflation, but the only difference that can be noticed is how the monetary policy is run. Forssback and Oxelheim (2007) further posit that there is a marked difference with how policy tools in the countries are utilised with the US having a more liberalised and transparent approach while China is highly controlled by the Communist government. Citing various examples, Green (2005) identifies marked difference in interest rate control where in the US the Fed controls only the short-end of the curve (Federal funds rate), the PBoC on the other hand controls rates across the board that is both lending and deposit rates. In terms of the open market operation monetary policy instrument Hsieh & Klenow (2009) postulates that there are also marked differences between these countries where the Fed rarely utilises this tool but the PBoC actively engages this tool through actions such as bill selling and reverse repo among others. For example when the interest rates in china decreased tremendously in 2007 and 2008, china’s economy was growing massively from investments in house, property values were increasing and housing bubbled. Property values started shrinking and the mortgages interest rates changed through monetary policy by open market operation as shown in Figure 4 below
  38. 38. China’s Monetary Policy 34 Figure 4: Monetary policy through open market operation between 2007 and 2008 Source: PBoC Annual Financial Report 2008 In terms of the reserve requirement, the same case applies where the Fed uses it much less, but the PBoC actively manipulate the reserve ratio requirement as this is largely related to the mechanism applied to arrange foreign exchange mechanism for the Chinese Yuan. In addition, as posited by Forssback and Oxelheim (2007) the PBoC utilises loan targets as a monetary policy, which is rarely used by the Fed, this is largely as a result of the domination of the Chinese financial sector by government owned banks making it possible for the government to direct how loans should be distributed. In the 2012, the PBoC reported that it is currently showing a different monetary policy compared to the Feds monetary policy and policies in other world’s economic power house. The balance sheet-to-GDP ratio has declined sharply in the year 2012; this is because the PBoC still has stringent measures on their monetary policies. They are not easing any of their monetary policy compared to Fed who has eased their monetary policies considerably. Figure 5 below shows the year on year percentage-point change of the PBoC balance sheet to GDP ratio
  39. 39. China’s Monetary Policy 35 Figure 5: Year on year percentage-point change of the PBoC balance sheet-to-GDP ratio Source: People’s Bank of China According to Frenkel et al. (2005), the Federal Reserve utilizes three main mechanisms of controlling the monetary policy including; trading treasury securities to reduce the monetary base, changing the discount rate, and infrequent adjusting the reserve requirement to influence the money multiplier. There appears to be similarities in mechanisms applied by the PBoC as it utilises three key instruments, namely reserve requirement, discount window and open market operation. The main difference in the utilisation of this mechanism is the level of government interference with the Fed more of an independent body as compared to the PBoC largely under the influence of the communist government. PBoC board consist of several members who are largely from the government and can be sucked by the government for their policies. However in
  40. 40. China’s Monetary Policy 36 Fed, the president appoints the governor who has to be accepted by the senate. The governor cannot be removed from office by anybody because of their policy view affirming the independence of the Fed. On the other hand, Hsieh & Klenow (2009) argue that with the intended reforms of the financial sector in China where it is hoped the PBoC will adopt the free market ideals utilised in the West, upon implementation the Chinese monetary policy application will largely be similar to those of developed nations in the west. One key reform that has been pushed or encouraged by the west is the need for the PBoC to allow the Chinese foreign exchange rates system to be determined by the forces of supply and demand since at the moment the Renminbi or the Chinese Yuan is highly undervalued against the world majors making Chinese exports cheaper.
  41. 41. China’s Monetary Policy 37 CHAPTER 5: DISCUSSION and ANALYSIS The main relations between China’s monetary policy and the commercial banks, namely ICBC and CCB can be categorised into the regulation of both lending and deposit rates by the PBoC in its attempts to stabilise the Chinese currency (Renminbi) as well as the economy at large. This as posited by Braun and K’orber (2011) is undertaken through the imposition of various monetary tools namely, reserve requirement, open market operation and discount window. The PBoC ensures the laid out policies are followed to the latter in order to achieve its own set inflationary targets as well as achieve robust economic growth. Through the use of monetary policy to influence how banks operate the PBoC has had untold success in promoting investment, economic growth and stability as well as ensuring the Chinese currency (Renminbi) stability through the regulation of lending and deposit interest rates charged by bank, influencing the amount of value of reserves that banks such as ICBC and CCB can hold at a given time in order to regulate money flow into the economy. As earlier mentioned, Braun and K’orber (2011) posit that there are three key approaches or tools of monetary policy that the PBoC utilises to regulate the banking sector each with its own effect on the same. To this end, Gilchrist and Zakrajsek (2007) are of the opinion that having reserve requirements in the monetary policy under the PBoC help limit the amount of money available to ICBC and CCB and other banks to lend to consumers. Braun and K’orber (2011) argue that this usually has the effect of controlling the amount of money in circulation in the process helping maintain or control inflation. In addition, Zhang & Wu (2012) posit that the PBoC determines the interest earned on reserves held by commercial banks thus having a say on the income generated by the banks. In addition, Braun and K’orber (2011) identified open market operation as another monetary policy that the PBoC employs to regulate the banking sector in China.
  42. 42. China’s Monetary Policy 38 To this end, McKinnon and Schnabl (2009) posit that this monetary policy aims at controlling the short term interest rate and the supply of base money in an economy, in the process controlling indirectly the amount of money supplied. As such this policy determines to a large extent the amount of interest rates that banks such as the ICBC and CCB can enjoy on various financial instruments such as national bonds, bills of the central bank and financial bonds. To this end, the PBoC can offer fewer bonds and other instruments in order to ensure that the interest rates remain low. On the other hand, Braun and K’orber (2011) argue that this monetary policy can be used to control the amount of money in circulation as the PBoC can buy bonds to increase money in circulation or sell bonds and other instruments to reduce the amount of money in circulation. Third, the discount window as postulated by Zhang and Wu (2012) the window guidance policy enables the PBoC to influence the operations of the banking and financial institutions as the money borrowed is charged a different interest rate from the existing market rate and banks have to indicate the amount of money out of the total borrowed they wish to loan out. This in essence determines the amount of money in circulation and available for lending at to a small extent the interest rates charged. For example, the PBoC may choose to advance a given amount of money to CCB on conditions that the amount borrowed will be used to offer credit to a given sector at a given rate putting in mind that the amount of money loaned to CCB belongs to the PBoC and as a lender of last resort is entitled to stipulate how the money will be used under the discount window borrowing. In addition, the PBoC has instituted various reforms ,with these reforms have resulted in the establishment of an effective financial infrastructure that promotes a highly elaborate lending and borrowing structure in Chinese commercial banks. The diverse money markets such as the
  43. 43. China’s Monetary Policy 39 uncollateralized loan market, the repo market and the inter-bank repo market are under the control of the PBoC and are largely influenced by the monetary policy adopted by the central bank, and as indicated within the paper, banks are the major players in this markets as such they have to abide by the rules set out by the PBoC through its monetary policy that governs issues such as interest rates, money supply and the amount of reserves that banks can hold at a given time. It is prudent to note that monetary policy conceptualisation and implementation functions are the responsibilities of central banks around the world. As posited by Geiger (2008), in China the PBoC interventions during the economic crisis of 2008 in addition to the reforms in the financial sector guarded the banking sector against scenarios that were witnessed in the West where large financial institutions such as Lehman Brothers, Northern Rock among others were at the blink of collapse had it not been for government stimulus packages. As such, the monetary policy adopted by the PBoC as argued by Frankel (2010) shielded the Chinese banking sector from being exposed by the toxic debt instruments that almost brought the financial sector in the US and Europe on its knees. To this end, Geiger (2008) argues that the reforms instituted in the financial sector in China by the PBoC through monetary policy instruments has resulted in a banking sector that has witnessed the development of financial markets in a steady and sound manner, efficient state of the corporate and household sectors, progress in financial infrastructure building and efficient functioning of the financial sector. With this in mind, the ICBC and CCB are major players in the Chinese financial market and have been significantly impacted by the reforms undertaken by the PBoC through various monetary policy instruments as indicated within this research paper. As such it can be arrived at that the monitory policy in China affects the ICBC and CCB in
  44. 44. China’s Monetary Policy 40 various ways, namely it has the effect of determining the banking sector profits where the interest charged on loans and other financial instruments is largely dictated by the monetary policy at the time. In addition, Koivu (2008) presents an important point regarding the impact of monetary policy on the banking sector in China (ICBC and CCB) where it is noted that the interest rates set by the PBoC through its quarterly adjustments play an important role in determining the investment spending in China. Why is this, the case? A higher interest rate set through the monetary policy will discourage borrowing in the process limiting investment as well as affecting the revenue earned by ICBC and CCB on interest from loans and other financial instruments, whereas, lower interest rates encourage borrowing resulting to higher interest income by banks. In addition, various theories seem to advise the critical role played by the monetary policy on the banking sector in China. The theory of money is posited by Marcuzzo (2001) the theories of money are applied in both private and public policy decision making processes with the aim of producing the expected economic outcomes such as economic growth and stable prices of goods and services. For example the Keynesian view as posited by Mata (2004) classifies the economy into two: real economy and monetary economy. In our case the monetary economy stands out as it influences the factors of valuation such as prices of goods and services, which are determined by the monetary policy adopted. High interest may have the effect of pushing up the price of goods and services with lower interest rates being of the contrary. This is a clear indication that the PBoC through various monetary policy adjustments has the power to influence the financial sector as it is responsible for ensuring that the Chinese economy can withstand any macroeconomic shocks. However as Geiger (2008) puts it, any
  45. 45. China’s Monetary Policy 41 monetary policy adjustment ought to be made through informed decisions that consider the prevailing economic conditions. Therefore, the impact of China’s monetary policy on ICBC and CCB mainly revolves around regulations in terms of how these banks operate and what levels of interest’s rates or reserves they can hold at a given time. The monetary policy in most cases is imposed to try salvaging a situation or preventing a given situation from occurring such as lowering the inflationary pressures by controlling the amount of money in circulation through instruments such as reserve requirement and open market operation. 6.0 Recommendation The research on the impact of monitory policy on the banking sector should be further expanded to look into how these new policy frameworks introduced into the banking sector by the PBoC in the bid to modernise the industry affects the operations of banks such as the ICBC and CCB. As these reforms may destabilise the financial sector it is prudent that the PBoC conducts a pilot study into the effects these reforms may have on the sector both in the short and long run. Therefore the impact of China’s monetary policy on the ICBC and CCB can be summed up as targeting or focusing on regulating the actions of these banks to ensure that they are in line with the monetary policy elements that the PBoC utilises to ensure the financial sector is stable and above all enhancing the economic development agenda of the Chinese government. There is also need to further look at the relationship and attitude of commercial banks towards the PBoC monetary policy once reforms are implemented as at the current state, commercial banks may be unwilling to air their deeply seated concerns in fear of reaction from the government, which in essence determines or is in charge of the regulation of the financial sector and banks may endure injustices on speaking out especially to researchers who may want critical information on the same issue.
  46. 46. China’s Monetary Policy 42 7.0 Conclusion As evident from the discussion, the impact of monetary policy on ICBC and CCB takes the form of regulations where the PBoC in charge of the monetary policy in China is mandated to impose rules as well as restrictions on issues such as interest rates charged on loans and the value of reserves banks can hold at a given time. To fulfil these roles, the PBoC utilises various monetary policy instruments such as open market operation, reserve requirement and discount window. Through the open market operation instrument, the PBoC controls or regulates the short term interest rates and the supply of money, as such banks such as the ICBC and CCB will have to operate under the interest rates limits or caps introduced by the PBoC and are constantly reviewed after some specified time. This policy also affects the amount of money in circulation in essence limiting how much the banks can advance as loans. The other instrument is the reserve requirement where the PBoC has set it at 10%, as such; this monetary tool by the PBoC effectively influences the lending policy of both ICBC and CCB as the amount they actively hold is determined to a large extent by the reserves policy dictated through the monetary policy. The discount window was also identified as another monetary policy instrument that the PBoC utilises to regulate the banking sector where under this instruments banks are encourage to freely and willingly adhere to the monetary policy in operation. In addition, various financial market reforms undertaken by the PBoC under its broad monetary policy were identified as having significant impact on how banks such as the ICBC and CCB will carry out their operations in the future. This new measures include establishing one and three year tenors, increasing the frequency of open market operations auctions, expanding the trading periods, and connecting the bill trading system to the payment system to
  47. 47. China’s Monetary Policy 43 ensure a pay on delivery system. This new approaches will demand that ICBC and CCB adopt the new measures in line with the PBoC agenda to liberalise and modernise the financial markets to mirror those of other developed countries. In conclusion, there needs to be an inward look into the benefits associated with a closely controlled financial system like the Chinese system in light with the 2008 economic crisis that was mainly as a result of de-regulation policies adopted by the west concerning the financial crisis. Chinese financial system did not experience banks bailouts during the height of the crisis and it is argued that when the West pumped billions of dollars into stimulus packages, China utilised the same amount to develop its infrastructure. As such, critical lessons can be learnt from the Chinese financial system and monetary policy approaches in order to forestall the occurrence of another financial crisis.
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