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Using confidential loan-level data, we examine how Basel III influenced
the responses of bank risk-taking to monetary policy shocks
in China. We use a difference-in-differences (DID) approach, exploiting
disparities in lending behavior between high- and low-risk
bank branches before and after the new regulations. Our findings
reveal a novel risk-weighting channel through which monetary policy
easing significantly reduced bank risk-taking. However, this
risk reduction was achieved by shifting lending towards ostensibly
low-risk state-owned enterprises (SOEs) with government guarantees,
despite their lower average productivity. Our findings suggest
a tradeoff facing China’s monetary policy between curbing bank
risks and addressing credit misallocation.
