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WP/09/189

What Drives China’s Interbank Market?
Nathan Porter and TengTeng Xu

© 2009 International Monetary Fund

WP/09/189

IMF Working Paper Asia and Pacific Department What Drives China’s Interbank Market? Prepared by Nathan Porter and TengTeng Xu1 Authorized for distribution by Nigel Chalk September 2009

Abstract This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Interest rates in China comprise a mix of both market determined interest rates (interbank rates and bond yields), and regulated interest rates (lending and deposit rates), reflecting China’s gradual process of interest rate liberalization. We argue, using a theoretical model and empirical analysis, that the regulation of key retail interest rates diminishes the ability of the market determined rates to act as independent price signals, or as benchmarks for use in asset pricing and monetary policy. Further interest rate liberalization should, therefore, strengthen the information conveyed by movements in interest rates, allowing for the better pricing of risk and capital. JEL Classification Numbers: E43, E52, E58 and C22 Keywords: Interbank market; monetary policy; GARCH; China Author’s E-Mail Address: [e-mail]; [e-mail]

1

Asia and Pacific Department, International Monetary Fund and Cambridge University, respectively. Most of the analytical work was undertaken while TengTeng Xu was an intern at the International Monetary Fund during Summer 2008. We thank, without implication, the People’s Bank of China, Nigel Chalk, Kai Guo and Laura Papi for their helpful comments.

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