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.

Interest rate liberalization in China intensifies the exposure of commercial banks' interest rate risks and further increases the difficulty for commercial banks to effectively control interest rate risks, thus putting forward higher requirements for the normal operation and management of commercial banks. With the development of China's financial derivatives market, banking institutions begin to use basic interest rate derivatives to hedge interest rate risks. It is very important to give full play to the maturity transformation Function of commercial banks to enhance the ability of financial services to the real economy. Based on the semi annual unbalanced panel data of 37 listed banks in A-share stock markets from 2006 to 2020, this paper empirically tests the impact of the use of off balance sheet interest rate derivatives on the Maturity Transformation Function of banks in the case of interest rate fluctuations. The empirical results show that: (1) the use of interest rate derivatives helps to weaken the negative impact of interest rate fluctuations on the Maturity Transformation Function of banks. (2) The analysis of the mechanism shows that the use of interest rate derivatives improves the stability of the bank's asset side term structure and liability side term structure, so as to support the effective play of the bank's financial intermediary role. (3) Further analysis shows that the of interest rate derivatives significantly reduces the volatility of bank earnings. This study makes it clear that the use of interest rate derivatives has a positive impact on the commercial banks, which provides evidence for the further development of interest rate derivatives market in China.

Shadow banking in China constitutes a dual-track interest rate reform that adds a new market track beside the controlled formal banking track. Shadow banking leads to Kaldor-Hicks improvement if the gains from financing the underfunded private enterprise (PE) and reducing bank capital idleness caused by ultrahigh reserve requirements outweigh the losses from shadow banking risk. Pareto improvement is feasible as the state-owned enterprise (SOE), a potential reform loser, participates in shadow banking to transfer credit to the more productive PE. Full interest rate liberalization, which removes formal banking controls after the dual-track reform, does not warrant additional profit gain if bank credit misallocation favoring the SOE and SOE's low productivity persist.

Financial repression—regulating interest rates below the laissez-faire equilibrium—has historically impeded investment in developing economies. In China, bank deposits were long subject to binding interest rate caps. Using transaction and local penetration data from a leading FinTech payment company, we study the FinTech’s introduction of a money market fund (MMF) with deposit-like withdrawal features but uncapped interest rates aids in interest rate liberalization. In aggregate, MMF assets grow rapidly, and banks whose deposit base was more exposed to the payment app see greater outflows. These outflows are concentrated in household demand deposits, for which the MMF is the closest substitute. Contrary to regulator concerns, exposed bank profitability does not decline. Rather, exposed banks invest more in financial innovation and are more likely to launch competing funds with similar features. Our results highlight how FinTech competition stimulates interest rate liberalization among traditional banks by introducing competition for funding.

What might interest rate liberalization do to intermediation and the cost of capital in China? China’s most binding interest rate control is a ceiling on the deposit rate, although lending rates are also regulated. Through case studies and model-based simulations, we find that liberalization will likely result in higher interest rates, discourage marginal investment, improve the effectiveness of intermediation and monetary transmission, and enhance the financial access of underserved sectors. This can occur without any major disruption. International experience suggests, however, that achieving these benefits without unnecessary instability, requires vigilant supervision, governance, and monetary policy, and a flexible policy toolkit.