Monetary Policy, Liquidity and Bank Risk-Taking

The great impact of monetary policy on bank risk-taking, facilitated by a liquidity mechanism, significantly complicates the macro-prudential supervision process. Surprisingly, limited scholarly research has delved into this particular issue. Hence, in this paper, the liquidity variable is introduced into the dynamic linear model to depict the liquidity mechanism by which monetary policy affects bank risk-taking. Based on micro-data from 133 commercial banks in China, this paper empirically tests using systematic Gaussian mixture models estimation and a panel smooth transition regression model. The findings reveal that while monetary policy does not exhibit a significant risk-shifting effect. A marked liquidity transmission effect, however, is observed, whereby easy monetary policy noticeably exacerbates bank risk-taking. This impact becomes more pronounced as liquidity levels improve. The most significant negative impact of monetary policy on bank risk-taking occurs when bank liquidity reaches approximately 43%. Moreover, when banks maintain high levels of liquidity, the statutory deposit reserve ratio exerts a greater regulatory effect than other monetary policy tools. Contractionary monetary policy imposes noticeably weaker restraints than expansionary monetary policy, particularly in banks with higher liquidity levels. Moreover, the interplay between monetary policy and bank risk-taking is contingent upon not just the liquidity level of banks, but also their asset size and capital adequacy.