Primary dealer status, endorsement signal, and bank funding costs

In China’s open market operations, the central bank selects a group of commercial banks each year to serve as primary dealers. We investigate the impact of the primary dealer status (PDS) on bank funding costs from a policy signal perspective, as measured by the NCD issuance rates. We find that the PDS significantly reduces banks’ funding costs. The endorsement signal mechanism indicates that the PDS enables banks to receive credit endorsement from the central bank, thereby conveying signals about their credit quality to investors and improving investor risk expectations. Furthermore, The PDS reduces banks’ allocation to shadow-banking-related risky assets, and mitigates their insolvency risk. This study offers important implications for enhancing the central bank’s institutions and supporting the sound management of banks.