This paper provides evidence on the cost of political interference on banks with Chinese Private Enterprise Survey data between 2002 and 2012. Using regional political turnovers as a proxy for political influence, we show that political motivations for future promotions distort the bank lending decisions and crowd out lending to private firms. Besides, firms with business connections are more sensitive to turnover, while political connections are not significantly affected. These lending distortions are more considerable where competition for future promotion is more intense and where incumbents have more influence over banks. Moreover, the effect is especially pronounced for small firms. As a result of reduced bank credit, firms’ total credit availability decreases and they have to cut investments. Overall, our results suggest that preferential lending to politically important sectors has negative spillovers and can lead to costly crowding-out of private sectors.

We study how bank liberalization affects analyst forecast accuracy using two interest rate deregulations in China—the removal of the cap on bank lending rates in 2004 and the removal of the floor in 2013—as quasi-natural experiments. Our results show that the analyst forecast accuracy for high-risk firms decreases significantly after the removal of the lending rate cap, whereas analyst forecast accuracy for low-risk firms increases significantly after the removal of the lending rate floor. Moreover, interest rate liberalization affects forecast accuracy through operational risk and information asymmetry channels. Furthermore, the impact was concentrated on firms whose actual performance fell short of performance expectations and those that received more bank loans. Our findings imply that interest rate liberalization policies may have unintended consequences for analyst forecasts.

Utilizing the removal of the bank lending interest rate floor (IRFD) in China as an exogenous shock of banking liberalization, we find that IRFD leads to a significant rise in firms’ cost of equity capital, which is consistent with the prediction from the MM theory. The identified effects are more pronounced among firms with weaker ex-ante corporate governance and more severe ex-ante agency problems. We also find that IRFD witnesses an increase in the amount of acquired bank loans, a decrease in the average interest rate, and an increase in free cash flow. Further evidence also suggests IRFD provokes a drop in firms’ investment quality. Overall, our findings highlight an unexplored role of banking sector deregulation on firms’ cost of equity capital.

We study how shadow banking affects the effectiveness of monetary policy in China.Using novel data on bank-issued off-balance sheet wealth management products (WMPs), we show that banks improve their on-balance sheet risk profile by issuing WMPs. This in turn lowers the sensitivity of banks' wholesale funding cost to monetary policy and reduces the effectiveness of the bank lending channel. The effect of our mechanism on total credit is quantitatively similar to the effect arising from the substitution between traditional loans and shadow banking loans previously analyzed in the literature. The channel documented in this paper has novel implications for the regulation of banks' off-balance sheet activities and market-based funding.

In geographically segmented credit markets, local real estate booms can divert capital away from manufacturing firms, create capital scarcity, increase local real interest rates, lower real wages, and cause underinvestment and relative decline in the industrial sector. Using exogenous variation in the administrative land supply across 172 Chinese cities, we show that the predicted variation in real estate prices does indeed cause substantially higher capital costs for manufacturing firms, reduce their bank lending, lower their capital intensity and labor productivity, weaken firms' financial performance, and reduce their TFP growth by economically significant magnitudes. This evidence highlights macroeconomic stability concerns associated with real estate booms.

We investigate how monetary policy in a mixed financial system such as that of China, which is characterized by a juxtaposition of quantity- and price-based policy instruments and the co-existence of regulated and market-determined interest rates, affects bank lending. Using a newly constructed loan-level dataset, we find that loan rates but not loan size are affected by both the regulated and the market-determined interest rates and that loan size is instead affected by an implicit quota that is imposed on aggregate bank lending through window guidance. We interpret this finding to be evidence of credit rationing.

The existing literature on political capital and bank lending has largely overlooked the role of political environment. Based on the theories of political marketplace, all-pay auction and political instability, we examine the conditional effect of political capital on access to bank loans with political environment surrounding private firms changing, using a nationwide survey of private firms in 2010. In particularly, we characterize the political environment with political capital inequality and political instability. We find that private firms have more difficulty gaining access to bank lending with the increase in the degree of political capital inequality. Furthermore, political capital exerts a positive effect on access to bank loans only when political capital inequality within a province exceeds 0.4775 and political instability does not exceed 0.7.

This study examines the relations between leverage and investment in China’s listed firms, where corporate debt is principally provided by stateowned banks. We obtain three major findings. First, there is a negative relation between leverage and investment. Second, the negative relation between leverage and investment is weaker in firms with low growth opportunities and poor operating performance than in firms with high growth opportunities and good operating performance. Third, the negative relation between leverage and investment is weaker in firms with a higher level of state shareholding than in firms with a lower level of state shareholding. Overall, our results are consistent with the hypothesis that the state-owned banks in China impose fewer restrictions on the capital expenditures of low growth and poorly performing firms and also firms with greater state ownership. This creates an over-investment bias in these firms.

Numerous papers in the “law and finance” literature have established that countries with better functioning legal institutions enjoy better developed capital markets, and that legal origin is a fundamental determinant of legal institutions (La Porta et al. 1997, 1998, 2006; Djankov et al. 2007). In this study, we test whether banks are willing to grant more credit to the private sector when they enjoy superior legal protection. We test this hypothesis using bank-level data from 45 emerging-market countries and a random-effects model that controls for bank heterogeneity. We find that lenders allocate a significantly higher portion of their assets to loans (i) where they enjoy English legal origin rather than French or Socialist legal origin; (ii) where enforcement of debt contracts is more efficient and (iii) where banks enjoy fewer restrictions on their operations. These support our hypothesis that superior legal protection leads to more bank credit, which, in turn, should lead to higher economic growth.

We present a model in which informational economies of scope that provide a cost advantage to universal banks oering “one-stop” shopping for lending and underwriting services also enable these intermediaries to “lock in” their clients’ subsequent business. This (limited) market power of universal banks reduces their incentive, relative to that of investment banks, to undertake costly eort in underwriting their clients’ securities. The consequent reduction in firms’ likelihood of successful security issues with universal bank underwriters prevents these intermediaries from using their scope economies to completely dominate their markets. Our analysis identifies economy, intermediary, and firm characteristics that motivate either the integration or segmentation of underwriting and bank lending. Our results also have implications for financial innovation and capital market development in markets characterized by the integration of financial services. Some of our empirical implications have not been tested; others can be compared with findings in Kroszner and Rajan (1994).