China s Bank Balance Sheet and Financing of Heterogeneous Enterprises

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1 economies Aricle China s Bank Balance Shee Financing Heerogeneous Enerprises Kun Huang 1, * Qiuge Yao 2 1 PBC School Finance, Tsinghua Universiy, Beijing , China 2 Insiue Economics, Universiy Chinese Academy Social Sciences, Beijing , China; yaoqiuge@163.com * Correspondence: huangk.15@pbcsf.singhua.edu.cn Received: 17 Sepember 2018; Acceped: 23 Ocober 2018; Published: 4 December 2018 Absrac: Given background financial disinermediaion ineres rae markeizaion, asses China s commercial banks can be divided ino radiional credi asses, whose raes reurn are conrolled by supervision deparmen, financial asses, whose raes reurn flucuae according o marke condiions. Direc financing enerprises are mainly sae-owned enerprises wih a good repuaion, endorsed by governmen, y finance using financial asses commercial banks. Indirec financing enerprises are mainly privae enerprises, which finance using credi asses. By inroducing a financial inermediary secor wih a balance shee ino dynamic sochasic general equilibrium DSGE) model, our model endogenously deermines leverage raio raio wo asses bank. Model resuls show ha impac from volailiy financial markes or exogenous shocks can affec banks asse proporions wo asse ypes, asymmerically affecing producion scale enerprises wih wo ypes financing. Furr, bank s leverage raio changes will have a magnifying effec on economic flucuaions. Keywords: bank balance shee; financial asses; credi asses; DSGE JEL Classificaion: E10; E12; E44 1. Inroducion 1.1. Increasing Aenion o Financial Insiuions Balance Shees In inernaional marke, global financial crisis 2008 has once again focused increasing aenion on financial insiuions balance shees. Many scholars have sudied amplificaion effec financial secor s balance shee deerioraion in process fermenaion spread financial crisis. As proposed by Inernaional Moneary Fund IMF 2008), subprime morgage crisis in Unied Saes reflecs weakness in balance shee. Yan 2008) saed ha roo cause his crisis was decline in balance shee individuals banking secor. The subprime crisis was no a crisis overcapaciy, bu essenially a financial insiuion s balance shee crisis, as poined ou by Li Song 2009). In China s financial marke, due o impac decreasing macroeconomic growh, financial disinermediaion, ineres rae liberalizaion in recen years, radiional credi business commercial banks is facing greaer challenges, previous high pri level banking indusry has gradually fallen, driving domesic banking indusry ino sage differeniaed compeiion. Bank asses coninue o il oward invesmen in securiies such as socks bonds. The diversificaion bank asses poses new challenges for commercial bank risk managemen provides a new channel for financing real economy. Economies 2018, 6, 65; doi: /economies

2 Economies 2018, 6, Economies 2018, 6, x FOR PEER REVIEW 2 25 Therefore, sudying new changes in bank balance shees will help unders impac financial sysem sabiliy on real economy financing. I has posiive significance for defusing financial risks achieving goal finance ha serves real economy New New Changes Changes in in Bank s Bank s Balance Balance Shees Shees According According o o characerisics characerisics a bank s bank s asses, asses, asses asses can can be be divided divided ino ino four four caegories: caegories: cash cash deposis deposis in in cenral cenral bank, bank, iner-bank iner-bank asses, asses, loans, loans, securiies securiies invesmens. invesmens. In In addiion, addiion, a bank s bank s asse-side asse-side subjecs subjecs include include precious precious meals, meals, derivaive derivaive financial financial asses, asses, long-erm long-erm equiy equiy invesmens, invesmens, ec. ec. Because Because proporion proporion se se asses asses does does no no exceed exceed 5% 5% oal oal asses, asses, has no has significan no significan impac impac on on daily daily operaions operaions bank, bank, se were se no were considered no considered here. Inerbank asses here. Iner-bank asses include include due from due or from banks, or lending banks, lending funds, funds, redempory redempory moneary moneary capial for capial sale. for Securiies sale. Securiies invesmens invesmens include rading include financial rading financial asses, available-for-sale asses, available-for-sale financial financial asses, held-omauriy invesmens, asses, held-o-mauriy invesmens, receivables. receivables. Receivables Receivables are mainly are inerbank mainly inerbank deposi deposi receips, receips, wealh wealh managemen managemen producs, producs, russ. The russ. asse The proporion asse proporion differen differen commercial commercial banks are banks slighly are slighly differen. differen. Figure Figure 1 shows shows rend rend in in proporion proporion bank bank asses. asses. The The loan loan is is sill sill larges larges proporion proporion asses asses held held by by commercial commercial banks. banks. Since Since 2010, 2010, cenral cenral bank bank has has raised raised deposi deposi reserve reserve raio raio commercial commercial banks banks in in order order o o alleviae alleviae inflaionary inflaionary pressures. pressures. Tigh Tigh moneary moneary policy policy has has gradually gradually reduced reduced proporion proporion loans. loans. In In 2015, 2015, regulaory regulaory auhoriies auhoriies coninuously coninuously issued issued documens documens o regulae o regulae developmen developmen iner-bank iner-bank business. business. Iner-bank Iner-bank asses asses have have been been shrinking shrinking since since n, n, scale scale securiies securiies asses, asses, which which can can be be seen seen as as a subsiue subsiue for for inerbank inerbank asses, asses, coninues coninues o o rise rise simulaneously. simulaneously. Overall, Overall, proporion proporion loans loans flucuaed around around 49%, 49%, proporions proporions securiies securiies asses asses iner-bank iner-bank asses asses were were around around 25% 25% 10%, 10%, respecively. respecively. Wih Wih coninuous coninuous advancemen in financial disinermediaion ineres rae liberalizaion, financial asses such as securiies securiies have have become become mos mos imporan imporan asse asse for for commercial commercial banks banks besides besides loans. loans Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan cash deposis in cenral bank securiies invesmens iner-bank asses loanrigh axis) Figure 1. The rend asses commercial banks. Daa sources: Wind). According o o Wind daabase, by by end end March March 2018, 2018, oal oal size size China s China s bond bond marke marke was 76 was rillion 76 rillion CNY. CNY. The ineres The ineres rae deb rae deb was was abou abou 41 rillion, 41 rillion, credi credi bond bond was was rillion, rillion, inerbank inerbank deposi deposi was 8.6 was rillion. 8.6 rillion. The size The size bonds held bonds by commercial held by commercial banks, banks, mos imporan mos player imporan in player bondin marke, bond was marke, abou 36.8 was rillion, abou 36.8 accouning rillion, for accouning 48.4% for 48.4% oal bond marke. oal bond marke. In summary, change in bank s asses is ha proporion radiional credi is gradually decreasing, In summary, while proporion change in financial bank s asses such is ha as bonds is proporion gradually increasing. radiional Therefore, credi is his gradually paper divides decreasing, bank asses while ino credi proporion asses financial asses. asses such Credi asses refer bonds is o radiional gradually loans increasing. banks, Therefore, which his are characerized paper divides by bank asses loan ineres ino credi raeasses being subjec financial o supervision asses. Credi canno asses refer floao freely. radiional The oal amoun loans banks, credi which assesare is characerized b loanby ineres loan rae ineres is R b. rae Financial being asses subjec refer o supervision o asses held bycanno banksfloa ha can freely. be publicly The oal raded amoun in financial credi asses markes, is b such as bonds, loan socks, b ineres rae inerbank is R. Financial deposi cerificaes. asses refer The o asses characerisic held by banks financial ha asses can be is ha publicly asseraded prices Qin financial markes, such as bonds, socks, inerbank deposi cerificaes. The characerisic

3 Economies 2018, 6, corresponding financial asse yields R k ) are no conrolled by regulaory auhoriies, bu rar, are affeced by macroeconomic environmen can flucuae wih marke condiions. The amoun financial asses held by banks is s. I is hough ha his seing can, o some exen, capure unique dual ineres rae sysem in China s financial sysem Reasons for Changes in Balance Shees The reasons for se new changes in erms bank s asses are boh from bank supply side funds, from enerprise dem side funds. The following is an overview se reasons from boh bank enerprise Banks The Supply Side Funds From experience inernaional banking developmen, financial mixed operaion has become an imporan means o improve compeiiveness banking indusry achieve economies scope. In 2006, China s Elevenh Five-Year Plan proposed o promoe inegraion financial indusry. Commercial banks, hrough acquisiions seing new subsidiaries, have gradually held licenses for public funds, financial leasing, insurance, securiies, russ Zheng 2016). Mixed operaion has broken original paern Bank, Securiies, Insurance which means divided operaion, leading o business inerpeneraion beween banks non-bank financial insiuions, changing characerisics capial flow srucure asses liabiliies. The proporion invesmen, equiy, inermediae business on balance shee will gradually increase. In his conex, besides radiional deposi loan business, business invesmen loan linkage, asse managemen, credi asse ransfer become imporan measures for commercial banks, o exp ir business operaions, innovae invesmen channels, increase pris. The unique dual rack ineres rae sysem China s financial sysem sill exiss. Before 2015, deposi loan ineres raes commercial banks were boh regulaed. Afer 2015, wih advancemen ineres rae markeizaion, alhough governmen has already assigned pricing power deposi loan ineres raes o commercial banks, deposi loan ineres raes are sill governed by supervision deparmen s window guidance. Similarly, marke ineres rae is dominaed by self-disciplined marke ineres rae pricing mechanism. The loan ineres rae can only be adjused wihin a cerain range. This resuls in bank s earnings from loans canno mach risk bank underakes, developmen radiional credi business is grealy limied. In conras, when banks allocae funds o financial markes, as a financial inermediary, bank s informaion superioriy, pressional, echnological advanages, makes i hink ha operaing financial asses can obain higher reurns han radiional credi, alhough y have o bear risks financial markes. The bank enriches asse side in order o mee capial adequacy requiremens. The capial adequacy raio is an imporan indicaor ha commercial banks need o address in asse managemen, is an imporan consrain for supervisory auhoriies o conrol bank managemen risks. In order o mee capial adequacy raio requiremens, commercial banks eir increase bank capial or reduce proporion high-risk asses, allocae more asses o low-risk asses Ming e al. 2017). This means ha issuing preferenial socks subordinaed debs o increase bank capial is difficul in shor erm. Therefore, in order o mee regulaory requiremens in a shor period, banks can only adjus curren asse srucure reduce proporion high-risk asses. According o Measures for Capial Managemen Commercial Banks, risk weigh naional deb policy financial bonds is 0, risk weigh local governmen bonds is 20%, risk weigh inerbank deposi cerificaes is 25%, risk weigh general enerprises is 100%. In order o mee regulaory requiremens, banks allocae asses in bonds, which can reduce capial occupaion banks beer mee capial adequacy raio requiremens. In addiion, compared wih loans, ineres bonds such as governmen bonds have a ax advanage. The issuance ineres-rae bonds, such as reasury bonds local governmen bonds, are no subjec

4 Economies 2018, 6, 6, 65 x FOR PEER REVIEW are no subjec o value-added ax income ax, while issuance loans are subjec o valueadded value-added ax a a rae ax 6%, income income ax, while ax is 25%. issuance loans are subjec o value-added ax a a rae o 6%, income ax is 25% Enerprises: The Dem Side Funds Enerprises: The Dem Side Funds The local governmen financing model has changed. As shown in Figure 2, proporion radiional The local credi governmen in social aggregae financing financing model has has changed. declined. As The shown main in reason Figure for 2, his is proporion ha local radiional governmen credi changed in social ir financing aggregaechannel. financing Yi has 2017) declined. proposed The ha main original reason for financing his is ha channel local is ha governmen banks provide changed credi ir for financing enerprises channel. wih governmen Yi 2017) proposed background. ha However, original financing afer channel inroducion is ha banks provide new Budge credi for Law enerprises Sae wih Council s governmen Opinions background. on Srengning afer Local inroducion Governmen Deb new Managemen, Budge Law local Sae governmen Council s Opinions financing onmodel Srengning has changed Localsignificanly. Governmen Deb Bank Managemen, loans are gradually local replaced governmen by governmen financing bonds. model The has paern changed where significanly. banks paricipae Bank loans in local are gradually infrasrucure replaced consrucion by governmen by loans bonds. o business The paern will be where hard o banks susain. paricipae Thus, commercial in local infrasrucure banks mus consrucion ransiion from by loans being o financing-oriened business will be hard businesses o susain. o invesmen-oriened Thus, commercial banks or inermediary-oriened mus ransiion from being businesses. financing-oriened businesses o invesmen-oriened or inermediary-oriened businesses Figure 2. The proporion radiional credi in social aggregae financing. Daa source: Wind). The naional indusrial srucure has been ransformed upgraded ino a paern ligh asses. A presen, China s economic indusrial srucure srucure has has undergone undergone a significan a significan change. change. The The added added value value eriary eriary indusry indusry accouns accouns for for almos almos half half gross domesic produc GDP). Heavy indusries wih high energy consumpion, heavy asses, low efficiency are gradually being subsiued by clean, ligh asses inelligence Yi Yi 2017). 2017). Specifically, Specifically, marke marke space space ligh ligh asse asse indusry, indusry, such such as as Inerne, Inerne, medicine, medicine, culural culural educaion, educaion, media, media, enerainmen, is is becoming increasingly exensive. The The heavy heavy asse asse indusries, indusries, such such as seel, as seel, coal, coal, cemen, cemen, are are under under remendous remendous pressure pressure o o de-capaciy simplify asses. In In process ligh asse ransformaion, i is difficul for enerprises o connec business, such as research developmen R&D) invesmen, inegraing operaional resources, mergers acquisiions, wih radiional bank loan business. This scenario has placed urgen requiremens for bank o esablish a comprehensive financial service framework for socks, bonds, loans. Based on above, sudying changes in bank balance shees in recen years will help analyze sabiliy China s financial sysem financial flucuaions. Therefore, his paper inends o include commercial bank s bank s balance balance shee shee as represenaive as represenaive financial secor financial secor mainsream macroeconomic mainsream macroeconomic model DSGE) model o examine DSGE) is o impac examine onis China s impac macro on China s finance. macro finance Conribuion This Paper Differen from from previous research on on macro finance, his his paper mainly inroduces improvemens in in following followinghree hreeaspecs. Firsly, Firsly, in in view view above above characerisics characerisics financial financial markes, markes, such such as asdual-rack dual-rack ineres ineres rae rae sysem sysem specific specific o o China, China, his his paper, paper, for for firs firsime, ime, includes characerisics bank asses ino DSGE model o analyze impac exernal facors, such as as financial marke impac echnological impac, on China s macro economy. Specifically, bank

5 Economies 2018, 6, financial marke impac echnological impac, on China s macro economy. Specifically, bank asses are divided ino financial asses credi asses. The price financial asses is direcly affeced by flucuaions in financial marke, so rae reurn can be flexible. The rae reurn on credi asses, namely ineres rae on loans, is conrolled by regulaors canno floa freely. Secondly, according o unique enerprise naure in China, his paper applies dem side credi asses, namely indirec financing enerprises, o large sae-owned enerprises. The dem side financial asses direc financing enerprises corresponds o privae small o medium size enerprises SMEs). The main reason for differences in financing channels beween sae-owned enerprises privae enerprises is ha yield characerisics credi asses financial asses are differen. Unlike sae-owned enerprises, privae SMEs have no governmen guaranee are highly risky. However, regulaed lending raes canno be adjused o mach risks privae enerprise. Therefore, enerprises wih differen ownership aribues choose differen financing mehods. This paper clearly describes his macroeconomic feaure China. Thirdly, according o DSGE model ha reflecs characerisics China s financial marke consruced in his paper, resuls his paper enrich balance shee channels in exising moneary policy ransmission mechanism. Empirical resuls, such as impulse response funcion, show ha ransmission channels are similar o radiional financial amplifier mechanism. Specifically, by inroducing financial inermediary secor wih a balance shee ino DSGE model, model can endogenously deermine a bank s leverage raio holding raio bank s wo ypes asses. The shock from financial marke will affec proporion financial asses credi asses held by bank, n asymmerically impac producion scale wo ypes financing enerprises. Through changes in bank s leverage raio, macroeconomic flucuaions are amplified. 2. Lieraure Review In early macro-financial lieraure, modeling ideas mainly concenraed on credi dem side, whereas banking secor is behavior as credi providers were rarely characerized. Before subprime morgage crisis, DSGE model, based on financial acceleraor collaeral consrain mechanism, did no explicily include a banking secor. For example, Iacoviello 2005) inroduced morgage consrain mechanism ino DSGE model as manifesaion financial fricion. Then, he assumed real esae price as an imporan asse price affecing real economy analyzed ransmission channel moneary policy. Afer crisis, DSGE modeling on bank capial mechanisms coninued o develop. Goodfriend McCallum 2007) inroduced a perfecly compeiive banking secor ino DSGE based on BGG model. The aricle inroduced banking secor o describe differences ineracions beween differen ypes ineres raes. In his aricle, asse side bank s balance shee is loan base currency, liabiliy side is deposi. In model Meh Moran 2010), exisence bank capial can alleviae agency problem beween banks deposiors, which affecs accumulaion loanable funds deposis), which in urn affecs expansion conracion economy. In model Gerler Karadi 2011), re is a moral hazard problem beween banks deposiors, so ha an incenive compaibiliy consrain was inroduced. This consrain makes banking secor s leverage endogenous links bank capial o exernal financing premiums. In model s balance shee, asse side is financial asses held by bank, liabiliy side is deposis bank capial. Dib 2009) examined role financial fricion in inerbank marke. The banking secor in aricle included wo heerogeneous sub-secors. Loans consised borrowings bank capial in inerbank marke. Banks have monopoly power so ha y can specify deposi loan ineres raes. Bank capial was inroduced in order o mee capial requiremens as a collaeral for inerbank marke. The inerbank marke model Gerler Kiyoaki 2010) focused on impac changes in value capial held by banks on inerbank marke lending bank balance shees. In his model, decline in value capial reduces value asses held by banks, which also reduces ir borrowing

6 Economies 2018, 6, capaciy. The reducion in borrowing capaciy furr reduces dem for corporae asses, reby furr reducing value corporae capial. In bank balance shee esablished by Gerler Kiyoaki 2010), deb side has newly added inerbank marke loans. Gerler e al. 2012) added bank equiy financing o liabiliy side bank s balance shee, which in urn made bank s risk exposure endogenous. In domesic research, Kang Gong 2014) inroduced bank s balance shee ino DSGE model in an open economy, divided enerprise ino heerogeneous expor non-expor enerprises. They sudied how inernaional economic crisis affecs a counry s expors, which in urn caused a loss bank asses in China. Liu Yao 2016) inroduced exogenous facors, such as asse price shocks, ino DSGE model wihin financial secor o explore impac se exogenous shocks on moneary policy goals. Wang Tian 2016) esablished a heerogeneous banking secor in which defauled probabiliy inerbank marke was endogenous, n discussed impac capial regulaion on sysemic financial risks. Overall, exising lieraure mainly focused on bank capial in balance shee. However, se sudies simply regarded a bank s asse side as one single asse, such as loans. There are a hful aricles involving financial asses, even fewer aricles have included credi asses financial asses simulaneously. The oreical model his paper is mainly based on Gerler Karadi 2011) Iacoviello 2005). The model in his paper is solved using value maximizaion problem following mehod inroduced by Gerler Karadi 2011). We also inroduce morgage consrain mechanism, which is similar o Iacoviello 2005). However, his model is differen from boh previous sudies. Iacoviello 2005) focused on impac real esae marke morgage consrain mechanisms on economy, did no explicily inroduce financial secor in model. Gerler Karadi 2011) did no disinguish heerogeneous producion enerprises or bank asses; his paper describes boh in deail analyzes impac on macro economy. Generally, radiional credi asses are sricly regulaed price credi asses is, o some exen, rigid. In conras, caegories financial asses held by banks are consanly enriched size financial asses are exping. The price financial asses freely vary wih marke condiions. Therefore, his paper focuses on laes changes in balance shee China s commercial banks, enriches asse-side seing, incorporaes credi asses financial asses ino balance shee simulaneously o examine impac exogenous shocks on economy. 3. Theoreical Model This paper consrucs a new Keynesianism- dynamic sochasic general equilibrium NK-DSGE) model, which is shown in Figure 3. The household provides labor o inermediae producers provides savings o banking secor. Banks n allocae deposis o wo ypes inermediae producers: direc financing enerprises indirec financing enerprises. Indirec financing enerprises are mainly sae-owned. Loan is financing mehod for such enerprises. Direc financing enerprises are mainly small- medium-sized privae enerprises, which are high risk canno obain financing suppor from radiional bank loan channel. They can only issue bonds in financial marke for financing. The producs inermediae enerprises are sold o packager. The packager packages goods sells m o reailer. The purpose inroducing reailers is o inroduce price sickiness. The reailer sells final produc o household for consumpion o capial producers for invesmen. The following secions describe deailed seings model.

7 Economies 2018, 6, Economies 2018, 6, x FOR PEER REVIEW 7 25 Figure 3. Theoreical model framework. Figure 3. Theoreical model framework Household 3.1. Household Suppose re is a coninuum homogeneous households, each which consumes, saves, provides Suppose labor. re Each is a household coninuum consiss homogeneous wo ypes households, members: each workers which consumes, bankers. saves, Workers provides provide labor labor. Each earn household wages for consiss family; wo bankers ypes manage members: financial workers inermediaries bankers. banks), Workers so provide family is labor owner earn wages bank for family; pris bankers earned are manage reurned financial o family. inermediaries Wihin a banks), represenaive so family household, is owner proporion bankers bank is f pris proporion earned are workers reurned is 1 o f. family. Wihin a represenaive In paricular, household, bankers face proporion a survival probabiliy bankers is f σ in each proporion period. A workers end is each 1 f. period, bank In paricular, has probabiliy bankers face σ a survival enering probabiliy nex phase. σ in each σ is independen period. A end hisorical each disribuion. period, Wher bank has banker probabiliy can ener σ enering nex period nex has phase. nohing σ is o independen do wih how many hisorical years disribuion. y have Wher survived in banker economy. can ener Through his nex assumpion, period has nohing average o do survival wih how ime many bankers years is y 1/1 have σ). survived The reason in why economy. banker s Through limied-erm his assumpion, survival hyposis average was survival inroduced ime is bankers o preven is 1/1 bankers σ). The from reason accumulaing why sufficien banker s pris limied-erm so ha survival y can hyposis fund all invesmen was inroduced from ir is o own preven capial. bankers from In accumulaing each period, sufficien re are pris 1 σ)f so bankers ha y who can exi fund from all invesmen financial inermediaion from ir own aciviies capial. become In each workers. period, In re order are o mainain 1 σ)f bankers raio who bankers exi from financial workers, inermediaion we assumed aciviies ha a similar become number workers. workers In become order o bankers mainain in each raio period, bankers family workers, provides we assumed sar-up ha funds a needed similar number for new bankers workers o carry become ou financial bankers inermediaion in each period, aciviies. family We inroduce provides his when sar-up inroducing funds needed financial for inermediaries. new bankers The o carry opimizaion ou financial issue for inermediaion represenaive aciviies. families is We as inroduce follows: his when inroducing financial inermediaries. The opimizaion issue for represenaive families is as follows: [ ] MaxE lnc +i hc +i 1 ) χ 1+ϕ 1+ MaxE i=0 ln C i hc + i 1 L1+ϕ +i L 1) + i s.. P 1+ C = W L + Π H + T + R D 1 D 1) i= 0 s.. PC = W L + + T + R D D H 1 where, in objecive funcion, C represens consumpion family, L represens labor supply family, β is ineremporal discoun facor family, h is parameer ha conrols where, in objecive funcion, C represens consumpion family, L represens ineria consumpion, ϕ is reciprocal Frisch labor supply elasiciy, χ indicaes labor weigh supply uiliy family, labor. Inis budge ineremporal consrain discoun equaion facor represenaive family, households, h is parameer P is ha priceconrols level, W isineria nominal consumpion, wage, Π H is is pri reciprocal ha family Frisch obains labor from supply elasiciy, ownership financial indicaes inermediaries weigh non-financial uiliy labor. enerprises, In Tbudge is lump consrain sum axes, equaion D is oal represenaive amoun deposis a beginning period, R H households, P is price level, W is nominal oal rae reurn deposi D is nominal wage, 1 is pri ha family obains from beginning period 1 o beginning period. Therefore, R D 1 is oal from ownership financial inermediaries non-financial enerprises, T is lump sum axes, D is oal amoun deposis a beginning period, R is nominal oal rae reurn deposi D 1 from beginning period 1 o beginning period. Therefore, RD 1 is oal income household in curren period. = P P 1 indicaes rae inflaion. We can obain firs-order condiion family opimizaion issue:

8 Economies 2018, 6, income household in curren period. Π = P /P 1 indicaes rae inflaion. We can obain firs-order condiion family opimizaion issue: P λ h = [ C hc 1 ) 1 βhe C 1 hc ) 1] λ h W = χl ϕ 2) E Λ,+1 R +1 ) = 1, Λ,+1 = λh +1 β λ h 3.2. Bank Bank Balance Shee In financial marke, commercial banks play role an inermediae beween supply dem funds. Banks can obain funds from wo sources: ir own reained earnings household deposis. Boh are wo ypes funds ha comprise liabiliy side bank s balance shee. Banks can inves in wo ways: a credi asse a financial asse. A beginning period, bank issues credi b for one period o enerprise, gains nominal oal rae reurn R b+1 when loan expires a end period. The number bonds issued by bank is affeced by value morgageable asses enerprise. Similarly, amoun financial asses issued by bank is S price is Q. Unlike credi asses, yield financial asses R k+1 is flexible, depending on performance financial marke. In shor, a bank s balance shee can be seen as following equaion: Q s + b = n + d 3) Evoluion Bank s Ne Worh n The change in a bank s equiy capial n depends on difference beween asse s reurn cos deposi: n = R k Q 1 s 1 + R b b 1 R d 1 4) We subsiued balance shee equaion ino above formula, eliminaed d, obained equaion as follows: n = R k Q 1 s 1 + R b b q R Q 1 s 1 + b 1 n 1 ) = R k R )Q 1 s 1 + R b R )b 1 + R n 1 5) Assume ha raio credi asses o financial asses is x, i.e., subsiuing x ino above formula, eliminaing b, obaining evoluion n produces: Moral Hazard Problem n = R k R )Q 1 s 1 + R b R )x 1 Q 1 s 1 + R n 1 = [R k R ) + R b R )x 1 ]Q 1 s 1 + R n 1 6) Given banker s financial consrains, y are moivaed o keep all pris unil y exi. When y exi, y will spend all ir accumulaed funds. Therefore, banker s goal is o maximize expeced discouned value ir fuure final dividend: ) V = E 1 σ)σ i 1 Λ,+i n +i i=0 7) because raes reurn R b R k are higher han ineres rae paid o deposiors R. Bankers have incenive o indefiniely absorb deposis from households exp ir asses. In order

9 Economies 2018, 6, o limi abiliy bankers o unresricedly exp ir asses, we inroduced a moral hazard problem: when a banker receives funds, y can diver a cerain proporion his fund for privae use. When households are aware his siuaion, y will no deposi money ino inermediary wihou resricion. The cos banker divering deposi for or purposes, is ha deposior can force bank o go bankrup liquidae, reby obaining ne value remaining porion 1 θ) bank. If household is willing o deposi money ino an inermediary, ne value bank mus be greaer han value i would have obained by divering deposi for privae use. The incenive compaibiliy consrain is following: V θx )Q s + b ) 8) Noably, we assumed ha proporion funds θ ha bankers can diver is a funcion x, θx ) = θηx + κ). The yield on credi asses is relaively fixed. I is easier for households o monior paymen defaul credi. However, re is a large degree uncerainy in reurn financial asses. Bankers can more easily diver financial asses in financial marke for privae purposes, while aribuing loss financial asses o financial marke risks. Therefore, larger x, higher credi asses proporion, lower proporion funds θ ha bankers can diver, i.e., η < 0. Subsiuing expression x ino θx ), consrain is: Bank Opimizaion V θηx + κ)1 + x )Q s 9) Bank opimizaion can be expressed as follows: s.. } V s, x, n ) = E Λ,+1 {1 σ)n +1 + σ max [V +1 s +1, x +1, n +1 )] s +1 x +1 n = [R k R ) + R b R )x 1 ]Q 1 s 1 + R n 1 10) V θηx + κ)1 + x )Q s The firs order condiions can be obained as follows due o space limiaion, soluion process is no deailed here; conac auhor if necessary): µ s = E [Λ,+1 Ω +1 R k+1 R +1 )] µ b = E [Λ,+1 Ω +1 R b+1 R +1 )] υ = E [Λ,+1 Ω +1 R +1 ] Ω +1 = 1 σ) + σµ s+1 + x +1 µ b+1 )ψ +1 + υ +1 ) ψ = Q s n = υ θ1+x )ηx +κ) µ s +x µ b ) 1 2 x + µ s = η + κ µ b 4η + κ η + κ)/4η 2ηx + η + κ 11) 12) 13) where ψ = Q s n is raio financing asses o capial financial inermediae Moion Equaion Toal Value Bank N In period, oal value bank N ) is equal o sum ne value bank ha survives from las period new bank ha eners in curren period. N = N o + N e 14)

10 Economies 2018, 6, where N o is ne value a bank ha has survived previous period, which equals survival probabiliy σ muliplied by is ne value. N e is ne value newly enered bank, which is equal o bank asses ha exi muliplied by proporion ω e /1 σ). The wo expressions are: N o = σ{[r k R ) + R b R )x 1 ]ψ 1 N 1 + R N 1 } = σ{[r k R ) + R b R )x 1 ]ψ 1 + R }N 1 N e = ωe 1 σ) 1 σ)q S 1 + B 1 ) = ω e Q S 1 + x 1 Q 1 S 1 ) 15) = ω e Q + x 1 Q 1 )S 1 In shor, oal value a bank can be expressed as a recursive form as follows: N = N o + N e = σ{[r k R ) + R b R )x 1 ]ψ 1 + R }N 1 + ω e Q + x 1 Q 1 )S 1 16) 3.3. Direc Financing Enerprises: Firm A Suppose re is a coninuum homogeneous enerprises measure uniy, each which use CES s Cobb-Douglas producion echnology. The firm produces oupu using capial K A labor L A. A is an exogenous producion echnology shock, subjec o a sable Markov process. ) α ) 1 α Y A = A K A L A 0 < α < 1 17) We assumed ha amoun capial ha enerprises obain hrough issuance financial asses is S. S, obained from bank financing in period, is capial prepared for producion period + 1, namely preparaion capial S. S is sum invesmen in period undepreciaed previous capial: S = I + 1 δ)k A 18) K A Afer impac ζ +1 capial qualiy in period + 1, S is convered ino producion capial ha can be pu ino producion in curren period: K A +1 = ξ +1S 19) The inroducion impac capial qualiy leads o an exogenous source change in capial prices. We assumed ha capial qualiy shock ξ +1 is an independen idenically disribued uncondiional mean one sochasic process. We assumed ha produc price firm A is P A. Solving pri maximizaion problem enerprise, we obained labor dem funcion pri rae per uni capial. P A Z A YA 1 α) L A = W A = PA YA W A L A K A = P A αa L A /K A ) 1 α 20) Based on expression Z A, we furr derived rae reurn per uni capial R k+1: R k+1 = ZA δ)q +1 Q ξ +1 21)

11 Economies 2018, 6, Indirec Financing Enerprise: Firm B The modeling indirec financing producers follows assumpions enrepreneurs in Iacoviello 2005). Specifically, companies maximize following issues by selecing consumpion C B, labor L B, credi financing loans)b, oupus Y B : [ MaxE β B+i ln C+i B +i+1)] hcb i=0 s.. Y B = A h v ) L B 1 v P B Y B + B + Q Bh 1 = P C B + W BLB + R bb 1 + Q Bh ) B me Q+1 B h /R b+1 22) where β B is discoun facor enerprise. β B < β is necessary in order o ensure ha such enerprises are ne borrowers funds in seady sae. The firs consrain equaion represens producion funcion firm B, which is similar o a direc financing enerprise. The produc facor is labor L B capial h, oupu is, ν is oupu share capial. The second consrain equaion represens budge consrain enerprise. The lef side is oal income curren period righ side is oal expendiure curren period. Q B is morgage asse price, W B is nominal wage worker, R b is ineres rae loan. The hird equaion is morgage consrain enerprise, indicaing ha amoun loan ha enerprise can obain B is affeced by expeced value asse ha can be morgaged. If firm B fails o repay loan on ime, firm will be liquidaed lender can obain proporion 1 m) borrower s morgage asses. Subsiue producion funcion ino budge consrain eliminaing Y B. Then, le λb be Lagrange muliplier corresponding o loan consrain λ BB be Lagrange muliplier corresponding o budge consrain. The firs-order condiion for B,L B,CB,h consrain equaions are par dynamic sysem Appendix A). Noably, ineres rae credi was regulaed by governmen in China before Alhough explici conrol deposi loan ineres raes was cancelled afer 2015, governmen window guidance sill exiss on deposi loan ineres raes. Therefore, i is assumed ha ineres rae credi funds is a fixed bonus deposi ineres rae: R b = R 1 + ) e ι 23) where e ι is exogenous window guidance shock. When eι is posiive, governmen wans o increase credi supply, R b declines, producion scale enerprise is exped Capial Producers A beginning each period for producion capial goods, capial producer purchases used old asses from inermediae produc producer final produc from final produc producer. The old asses purchased from producers, x k, = 1 δ)k A, are convered ino new asses one-o-one, so purchase price is. The final produc purchased from final produc manufacurer AI, I 1 ) is used for invesmen purchase price is P. The maximizaion problem is following: MaxE β i λ h { } +i Q+i [x k,+i + AI +i, I +i 1 )] Q +i x k,+i P +i I +i 24) i=0

12 Economies 2018, 6, The firs-order condiion I is: E [ λ h Q A 1, P ) + βλ h +1 Q +1A 2, ] = 0 A 1, = AI,I 1 ) I, A 2, = AI,I 1 ) I 1 [ AI, I 1 ) = 1 S I I )]I 1, S I I 1 ) 25) ) 2 = S I 2 I 1 1 We se λ hn = λ h P, n firs-order condiion above is: [ ) 2 ) ] λ hn Q P 1 S I 2 I 1 1 S I I I 1 I 1 1 ) λ hn ) + βλ+1 hn Q 2 +1 P S I I +1 I 1 I 1 1 = 0 26) In summary, equaion moion capial is: 3.6. Packagers Reailers Packagers K A +1 = ζ +11 δ)k A + AI, I 1 ) 27) The packagers purchase above wo ypes producion, Y A Y B, from marke, use CES producion echnology o produce combined goods y, sell m o reailer. The price combined producs is P. The issue maximizing pri in producion is: MaxP y P Y A A P A P BPB YB [ s.. y = ω 1/ε y y The firs-order condiion for Y A Y A ) εy 1)/ε y + 1 ω y ) 1/εy Y B ) εy 1)/ε y ] εy /ε y 1) is: y ) 1/ε y Y A ) 1/εy = P A P ω 1/ε y y 28) 29) The firs-order condiion for Y B is: ) y ) 1/ε y Y B 1/εy P B = ) 1/εy 30) P 1 ω y Since packager is compleely compeiive, final pri is 0: We, refore, obained following equaion: P y P A P A P B P B = 0 31) P = [ ) 1 εyωy ) 1 εy P A + P B ) ] 1/1 ε y ) 1 ωy 32)

13 Economies 2018, 6, Reailer The purpose modeling reailers is o inroduce price sickiness. Suppose re are {0, 1} infiniely numerous monopolisic reailers. Reailer f buys goods y from packers. Goods are convered ino Y f using a 1:1 producion echnique. The final consumer produc is: [ 1 Y = 0 Y ε 1)/ε f d f ] ε/ε 1) 33) From minimizaion cos final produc, we obained following equaion: Y f = In summary, reailer s pricing problem is: Max E {P } i=0 s.. Y f = The firs order condiion is: [ E γ i β i λhn +i P i=0 λ hn 3.7. Cenral Bank ) [ εy 1 ] 1/1 ε) P f /P, P = P 1 ε f d f 34) 0 [ γiβi λhn +i P i λ hn P +i 1 + π +k 1 ) γ p p +i ]Y f +i k=1 ) 35) εy P f /P i P +i k=1 1 + π +k 1 ) γ p µp +i ]Y f +i = 0, µ = 1/1 1/ε) 36) The cenral bank s moneary policy is subjec o following Taylor rules: R +1 = R ) κ γ 1+κπ y ) 1 κγ Y /Y)κ γ e γ 37) where R is marke ineres rae residen s deposi ineres rae), moneary policy peg ineres rae is R 1, inflaion rae is Π, oupu gap is Y /Y, where γ is ineres rae policy goal e γ is moneary policy shock Marke Clearing Condiions The clearing condiions for commodiy marke labor marke are as follows: 4. Parameer Esimaion L A + L B = L ω l W A + 1 ω l) W B = W 38) C + C B + AI, I 1 ) = Y The above oreical model has a oal 41 equaions 41 endogenous variables. Afer we ransformed nominal variables ino acual variables, dynamic sysem was log-linearized. The full equaions model are deailed in Appendix A. For some parameers model, direc calibraion indirec calibraion were used for assignmen. The values parameers are shown Table 1. The remaining parameers model can be esimaed using Bayesian esimaion.

14 Economies 2018, 6, Table 1. Model parameer calibraion. Parameer Descripion Value Parameer Descripion Value β Household ineremporal discoun facor υ Capial oupu elasiciy indirec financing enerprise h Consumpion ineria m Morgage rae for loans 0.7 χ Labor weighing Credi rae mark up 1.5 ϕ Frisch elasiciy labor supply 0.33 ω y financing enerprises Proporion direc producs in porfolio σ Bank survival probabiliy ε y wo ypes Subsiuion elasiciy enerprises θ Proporion funds divered by banker ε Subsiuion elasiciy reails η Moral hazard coefficien ω l Combinaion raio wo ypes labor κ Moral hazard coefficien γ Price sickiness 0.75 ω e α Proporion asses reained by exied bankers Capial oupu elasiciy direc financing enerprise γ p Price index s weigh for inflaion seady sae κ γ Ineres rae smoohing δ Capial depreciaion rae κ π Weigh expeced inflaion in Taylor rule β B Enrepreneur ineremporal discoun facor 0.95 κ y Weigh oupu gap in Taylor rule Calibraion The firs sep is direc calibraion parameers. The values se parameers are shown in Table 1. According o Qiu Zhou 2014), household s ineremporal discoun facor β was se o In ligh Zhuang e al. 2012), consumpion ineria h was se o According o Gerler Karadi 2011) Angeloni Faia 2013), bank survival probabiliy σ proporion funds divered by banker θ were se o , respecively. We use esimaes from Mei Gong 2011) o calibrae Frisch elasiciy labor supply ϕ 1. Mos lieraure valued China s capial oupu elasiciy beween , such as Du Gong 2005), Lv Huang 2011). In addiion, direc financing enerprises conain SMEs whose capial share is lower han ha sae-owned enerprises. Therefore, capial oupu elasiciy direc financing enerprise α should be smaller han capial oupu elasiciy indirec financing enerprise υ. According o Chen Zhang 2010), capial oupu elasiciy direc financing enerprise α capial oupu elasiciy indirec financing enerprise υ were se o , respecively. The depreciaion rae physical capial δ is relaively uniform in domesic lieraure, which was se o 10% per annum Shan 2008). According o PBC s regulaions on down-paymen raio residenial morgage loans, we se morgage rae for loans m o 0.7. Given Chen Zhang 2010) findings, we se proporion direc financing enerprises producs in porfolio ω y, subsiuion elasiciy wo ypes enerprises ε y combinaion raio wo ypes labor ω l as 0.4, Price sickiness γ subsiuion elasiciy reails ε were calibraed o , respecively, which follow convenional seings. According o Wind daabase, credi spread beween deposis loans is increasing. In recen years, China s deposi ineres rae six monhs) is abou wo o hree imes ha loan ineres rae six monhs). Therefore, credi rae markup was se o 1.5. China s moneary policy is sensiive o changes in oupu, is slow o respond o inflaion Tang

15 Economies 2018, 6, Liu 2012). According o findings Chen e al. 2017), response coefficiens oupu κ y inflaion κ π in Taylor rule were se o , respecively. Nex, we indirecly calibraed hree parameers: Banker moral hazard facor η κ, proporion asses reained by exied bankers ω e. By seing values se hree parameers, following hree objecives were achieved: firs, x value a seady sae raio credi asses o financial asses) was hree. Second, value R k R b a seady sae credi spread wo ypes asses) was 50 bp or 0.5%. Third, value ψ a seady sae raio financial asses o ne asses bank) was hree. The following describes why we chose arge indirec calibraion a se values. Firs, as can be seen from Figure 1, raio loans held by China s banking indusry o financial asses mainly bond asses inerbank asses) was mainained a approximaely 3:1. Second, reason why we hough ha some eniies canno obain funds hrough radiional credi channels is ha radiional loan ineres rae is regulaed. The ineres rae se by regulaor is oo low o mach defaul risk small- medium-sized enerprises. The financial marke can mach defaul risk se enerprises wih higher bond ineres raes. Therefore, we se R k a seady sae o be greaer han R b mainained spread a 0.5%. Third, regulaion requires commercial banks o have a capial adequacy raio greaer han 8%, so we se raio bank capial o financial asses o hree Bayesian Esimaion The Bayesian mehod was used o esimae remaining parameers. These parameers were mainly firs order auocorrelaion coefficien exogenous shock variance in disurbance erm. In order o avoid problem sochasic singulariy, number observaion variables could no exceed sum exogenous shock observaion error. There are five exogenous shocks in his paper. Therefore, daa used in Bayesian esimaion were GDP, consumer price index CPI), deposi ineres rae commercial banks hree monhs), raio credi asses financial asses sae-owned banks, raio financial asses bank s capial sae-owned banks. The daa ranged from firs quarer 2010 o fourh quarer The daa were obained from Chinese macroeconomic daabase Chun e al. 2015) quarerly repors commercial banks. The nex sep was o separae cycle from rend. We needed o remove rend componen from observaion daa. In earlier sudies, linear rend mehod was used o absrac cycle componens from ime series. Nelson Plosser 1982) found uni roos in mos macroeconomic sequences, indicaing non-saionariy macro ime series. Hereafer, linear rend mehod based on saionariy sequences los is value-in-use. There are wo kinds decomposiion mehods for economic cycle: non-parameric filering mehods, such as Hodrick-Presco filer B-Pass filer; model-based ime series decomposiion mehods, such as Beveridge Nelson decomposiion mehod Kalman decomposiion mehod. Afer a comprehensive analysis various mehods, Canova 1998) saed ha differen mehods reveal differen characerisics daa. By analyzing China s macroeconomic daa, Sun 2013) supposed ha, compared wih frequency domain mehods such as HP filer, resuls obained by BN decomposiion avoid pseudo-cycles problem, which means resuls are more sable. Therefore, in his paper, BN decomposiion mehod was adoped o separae cycle componens five shocks, which were subsequenly used for esimaion. The prior disribuion poserior means Bayesian esimaes are repored in Table 2. The 90h percenile poserior disribuion parameer was obained hrough Meropolis Hasings sampling algorihm, which is based on 100,000 samplings.

16 Economies 2018, 6, Parameer Prior Disribuion Table 2. Bayesian parameer esimaion resuls. Prior Mean Prior 90% Confidence Inerval Poserior Disribuion Poserior 90% Confidence Inerval S 1) Uniform Bea Bea Bea Bea Bea Inv-gamma Inv-gamma Inv-gamma Inv-gamma Inv-gamma Variance Decomposiion Impulse Response Analysis 5.1. Variance Decomposiion The conribuion each srucural shocks o forecas error variance endogenous variables a various horizons is repored in Table 3. Specifically, oupu, consumpion, inflaion which reflec real economy, are mos sensiive o changes in moneary policy. In conras, financial shocks more seriously affec financial marke indicaors, such as asse prices. When exogenous financial marke shock occurs, i is financial asse price ha bears brun. Furrmore, hrough bank balance shee ransmission mechanism, bank ne worh is be correspondingly affeced by financial shock. To furr illusrae how financial variables change wih exogenous shocks, following figures show hisorical variance decomposiion hree variables: rae reurn on financial asses, raio credi asses o financial asses, raio financial asses o bank s ne worh. Table 3. The variance decomposiion economic variables. Supply Shock Supply Shock Financial Shock Window Guidance Moneary Shock Hisorical Variance Decomposiion From Figure 4, i can be seen ha financial marke shock moneary policy shock grealy impacs on rae reurn financial asses. Specifically, Figure 4 depics following informaion. The volailiy in financial asse yield rae is opposie o volailiy in financial marke impac. I can be inferred from basic knowledge finance ha a posiive financial shock causes price financial asses o rise, which is equivalen o reducing rae reurn financial asses. Therefore, i is no difficul o unders why above wo flucuae wih opposie rends. Second, in each period, moneary policy shocks are almos opposie financial marke shocks. This is an ineresing phenomenon. The occurrence his siuaion reflecs characerisic moneary policy o lean agains wind. When financial markes encouner posiive exernal shocks, rise in financial asse prices will cause bank o ransfer credi funds o financial asses. In order o curb overheaed financial markes, moneary policy makers working on couner-cyclical regulaion will ighen moneary policy reduce supply credi. As such, commercial banks find ha re are

17 asses. Therefore, i is no difficul o unders why above wo flucuae wih opposie rends. Second, in each period, moneary policy shocks are almos opposie financial marke shocks. This is an ineresing phenomenon. The occurrence his siuaion reflecs characerisic moneary policy o lean agains wind. When financial markes encouner posiive exernal shocks, rise in financial asse prices will cause bank o ransfer credi funds o financial asses. In order Economies 2018, 6, o curb overheaed financial markes, moneary policy makers working on couner-cyclical regulaion will ighen moneary policy reduce supply credi. As such, commercial banks find ha nore available are no funds available o inves funds ino inves financial marke, financial hus marke, inhibiing hus inhibiing supply supply funds funds prevening prevening emergence emergence financial marke financial bubbles. marke bubbles. Figure 4. Hisorical decomposiion reurn rae financial asses R k based k on poserior mean Figure 4. Hisorical decomposiion reurn rae financial asses R based on poserior esimaes parameers Kalman smood mean esimaes shock. The y-axis represens mean percenage esimaes poin parameers deviaion from seady Kalman sae. smood The full line mean represens esimaes ˆR shock. k The y-axis, which means k deviaion represens from seady percenage sae poin value deviaion R k. The from following seady figures sae. The are full similar. line represens R, which Economies 2018, 6, x FOR PEER REVIEW k Figure means 5 shows deviaion from hisorical seady variance sae value decomposiion R. The following figures raio are similar. credi asses o financial asses. policy Firs, shock financial is accompanied shocks lead by o flucuaions decline in inproporion raio credi asses o financial asses. asses Second, in volailiy same Figure period. is 5 shows almos From consisen hisorical previous wih variance analysis, moneary decomposiion negaive policy moneary shock, raio policy meaning credi curbs asses negaive flow o financial moneary credi policy asses. shock Firs, isfinancial accompanied shocks lead by o flucuaions decline in in proporion raio credi credi asses asses o financial financial asses. Second, funds o financial markes, i.e., negaive moneary policy curbs decline x asses in. Therefore, i is same volailiy period. is almos From consisen previous wih analysis, moneary negaive policy moneary shock, meaning policy curbs negaive flow moneary no difficul o unders why re is a posiive correlaion among se wo variables, suggesing credi funds o financial markes, i.e., negaive moneary policy curbs decline x. Therefore, i is no ha igher moneary policy has no fully suppressed decline x difficul o unders why re is a posiive correlaion among se. wo variables, suggesing ha igher moneary policy has no fully suppressed decline x. Figure 5. The hisorical variance decomposiion raio credi asses o financial asses x. Figure 5. The hisorical variance decomposiion raio credi asses o financial asses x. Figure 6 depics hisorical variance decomposiion raio financial asses o bank ne worh ψ. Firs, leverage raio financial asses financial shock change synperiodically. The negaive Figure 6 depics hisorical variance decomposiion raio financial asses o bank ne financial shock reduces price financial asses, which reduces bank s allocaion financial asses. Second, worh in recen. Firs, years, leverage China s raio moneary financial policy asses has shown financial a srucural shock characerisic. change synperiodically. Specifically, The in same negaive period, financial moneary shock policy reduces shocks price window financial guidance asses, which shocks reduces move inversely bank s wih allocaion each or. financial asses. Second, in recen years, China s moneary policy has shown a srucural characerisic. Specifically, in same period, moneary policy shocks window guidance shocks move inversely wih each or. Besides ighening moneary policy by increasing moneary policy rae, cenral bank reduces lending rae credi funds, which guaranees ha SME financing coss are unchanged.

18 Figure 6 depics hisorical variance decomposiion raio financial asses o bank ne worh. Firs, leverage raio financial asses financial shock change synperiodically. The negaive financial shock reduces price financial asses, which reduces bank s allocaion financial asses. Second, in recen years, China s moneary policy has shown a srucural Economies 2018, 6, characerisic. Specifically, in same period, moneary policy shocks window guidance shocks move inversely wih each or. Besides ighening moneary policy by increasing moneary Besides policy ighening rae, cenral moneary bank policy reduces by increasing lending rae moneary credi policy funds, rae, which cenral guaranees bank reduces ha SME lending financing rae coss credi are funds, unchanged. which guaranees ha SME financing coss are unchanged. Economies 2018, 6, x FOR PEER REVIEW Figure Financial Figure The Shock The hisorical hisorical variance decomposiion raio raio financialasses asseso obank bank ne ne worh worh ψ.. Figure 7 simulaes impac financial marke volailiy on macro economy. A 1% 5.3. Financial Shock negaive volailiy shock in financial marke immediaely lead o a fall in price financial Figure 7 simulaes impac financial marke volailiy on macro economy. A 1% negaive asses Q. The financial marke recession leads o an increase in various ineres rae indicaors, volailiy shock in financial marke immediaely lead o a fall in price financial asses including benchmark ineres raes financial asse yields. However, reurn on financial asses Q. The financial marke recession leads o an increase in various ineres rae indicaors, including ha are more closely linked o financial marke will be more inense, leading o an increase in benchmark ineres raes financial asse yields. However, reurn on financial asses ha are more spreads closelyrklinked Rb. Simulaneously, o financial marke decline will in be financial more inense, asses price leading causes o banks increase o reduce in spreads ir R k R b. Simulaneously, decline in financial asses price causes banks o reduce ir holdings holdings financial asses. S also declines. financial asses. S also declines. Figure 7. Impulse response diagram financial marke shock. Figure 7. Impulse response diagram financial marke shock. Along wih sudden loss bank s financial asses, bank s ne asse value n also fall. Due o leverage raio beween financial asses bank s ne asses, decline in value bank s ne asses will be even greaer, reaching around 7%. The reducion in value

19 Economies 2018, 6, x FOR PEER REVIEW According o our model, direc financing producers are financed by issuing markeable ineress in financial markes, indirec financing producers are financed hrough bank credi. Flucuaions Economies in financial 2018, 6, 65marke affec producion scale boh ypes producion enerprises. The impac on direc financing producers is more obvious. As can be seen from impulse response graph Figure 8), oupu direc financing firms falls by abou 4%, while oupu indirec financing Along wih sudden loss bank s financial asses, bank s ne asse value n also fall. producers falls by abou 1.5%. The decline in oupu wo ypes producion companies Due o leverage raio beween financial asses bank s ne asses, decline in value ulimaely leads o a decline in oal social oupu. bank s ne asses will be even greaer, reaching around 7%. The reducion in value bank s The decline in asse prices causes bank s asses o conrac, which in urn leads o a ne asses leads o a conracion in issuance credi asses hrough leverage wihin banking conracion deb side, reby reducing reurn on household savings. A reducion in sysem. Once again, due o leverage raio wihin banking sysem, size credi asses falls producion scale a producion enerprise reduces labor employmen, labor compensaion by around 5%. Therefore, in erms oal amoun, scale credi asses financial asses received by family decreases. In shor, oal income family decreases, hus oal declines due o financial marke volailiy depreciaion bank s ne asses. consumpion decreases. Because financial marke volailiy reduces income financial asses, financial asses are no Depiced in impulse response graph, volailiy shock from financial marke firs longer srongly aracive o banks. A his ime, sable safer characerisics credi asse affecs yield financial asses, n affecs holding raio financial asses credi income causes banks o allocae more capial o credi asses on asse side, resuling in an increase asses. This has an asymmeric impac on producion scale wo ypes producion in raio credi asses o financial asses x. Therefore, in erms proporion, decline in enerprises. The endogenous changes in leverage banking secor caused by exogenous size financial asses is more obvious han shrinking credi asses. impac financial marke will evenually have a magnifying effec on economic flucuaions. According o our model, direc financing producers are financed by issuing markeable ineress in 5.4. financial Moneary markes, Policy Shocks indirec financing producers are financed hrough bank credi. Flucuaions in financial marke affec producion scale boh ypes producion enerprises. The impac on direcfigure financing 8 depics producers is impac more obvious. a 1% ighening As can be seen moneary from policy impulse shock response key graph macroeconomic Figure 8), variables. oupu The direc impulse financing response firms graph falls by shows abou ha 4%, igh while moneary oupu policy indirec curbed financing social dem producers such falls as consumpion by abou 1.5%. The invesmen, decline in wih oupu wo wo falling ypes by 2.4% producion 0.7% companies respecively, ulimaely leads oal o social a decline oupu in also oal falling, social oupu. wih oal oupu falling by 1.8%. Figure 8. Impulse response diagram moneary policy shock. Figure 8. Impulse response diagram moneary policy shock. The decline in asse prices causes bank s asses o conrac, which in urn leads o a conracion deb side, reby reducing reurn on household savings. A reducion in producion scale a producion enerprise reduces labor employmen, labor compensaion received

20 Economies 2018, 6, by family decreases. In shor, oal income family decreases, hus oal consumpion decreases. Depiced in impulse response graph, volailiy shock from financial marke firs affecs yield financial asses, n affecs holding raio financial asses credi asses. This has an asymmeric impac on producion scale wo ypes producion enerprises. The endogenous changes in leverage banking secor caused by exogenous impac financial marke will evenually have a magnifying effec on economic flucuaions Moneary Policy Shocks Figure 8 depics impac a 1% ighening moneary policy shock on key macroeconomic variables. The impulse response graph shows ha igh moneary policy curbed social dem such as consumpion invesmen, wih wo falling by 2.4% 0.7% respecively, oal social oupu also falling, wih oal oupu falling by 1.8%. Firs, ighening moneary policy impacs financial secor. Tighening moneary policy will raise ineres raes. However, since financial markes are less consrained regulaed han radiional credi markes, ineres raes in various markes are no exacly same. Specifically, in financial marke, asse prices fall by nearly 0.3% yield financial asses rise sharply. Compared wih credi ineres raes, spread financial asses rises by more han 0.2%. The decline in yield financial asses direcly causes banks o reduce amoun financial asses held by ir banks, decline in holdings is abou 5%. Because yields boh credi asses financial asses are differen, reducion in oal size wo ypes asses is also differen, financial asses shrink more significanly. Therefore, raio wo rise relaively, wih an increase abou 4%. A same ime, decline in price financial asses leads o a reducion in bank pris, bank s ne asses also decline. Wih economic downurn, banks are generally no longer opimisic abou financial marke reduce leverage raio financial asses. The curren period ψ also declines by abou Second, upward rend in ineres raes leads o an increase in invesmen coss a decrease in enrepreneurs willingness o inves. Along wih conracion various financing markes, corresponding producion companies also reduce ir producion scale. Producers financed hrough financial asses are more affeced, wih producion falling by abou 2%. The oupu producers financed hrough credi also falls by abou 1.5%. In shor, scale producion enire sociey declines. The reducion in oal social supply causes an increase in prices, inflaion rae increases by abou 0.9%. Noably, consumpion shows a decreasing rend, by abou 2.4%. We hink ha re are wo reasons for his phenomenon. Firsly, rise in ineres raes may increase reurn on savings, people are more willing o save money han consume, which leads o a reducion in consumpion. Secondly, reducion in oal social supply also reduces oal amoun producs available for consumpion, which also inhibis oal social dem o some exen. 6. Conclusions Due o unique ineres rae dual-rack sysem, deposi loan ineres raes radiional bank credi business are subjec o more governmen regulaion. The yields securiies circulaing in financial marke, such as bonds, can flucuae wih marke flucuaions, are less consrained by governmen, which can reflec macroeconomic environmen more realisically. Accordingly, we divided asses held by China s commercial banks ino credi asses financial asses. The model includes wo ypes producive enerprises: direc financing indirec financing. The former are financed by issuing financial asses in marke, laer are financed hrough bank credi asses. By consrucing a DSGE model conaining a bank s balance shee, we characerized impac differen exogenous shocks on macroeconomics hrough bank s balance shee channel.

21 Economies 2018, 6, The resuls impulse response show ha negaive impac from financial marke will shrink size boh ypes asses. However, reurn on credi asses is regulaed by governmen scale is limied, resuling in differen conracion raios for wo ypes asses. Furrmore, producion scale wo ypes producive enerprises also shows an asymmeric conracion. A shock from supply side will cause price financial asses o rise, spread wo ypes asses will shrink. Moreover, size boh ypes asses exps a same ime. The impac from igh moneary policy leads o an increase in yields various asses, scales various asses shrink. Loan ineres raes conrolled by governmen increase less han yield financial asses, so spread wo ypes asses exps, banks allocae more asses o credi asses. This resuls in a relaive increase in proporion credi asses asymmeric conracion wo ype enerprises producion scale, ha is, decline in oupu direc financing enerprises is more obvious. Based on exising lieraure, his paper exps single-ype asses held by banks ino wo ypes asses wih differen characerisics, explains economic flucuaions in China from perspecive bank asses, hus providing a new perspecive for undersing China s macroeconomic flucuaions. Auhor Conribuions: Concepualizaion, K.H. Q.Y.; Daa curaion, Q.Y.; Mehodology, K.H.; Sware, K.H.; Wriing original draf, K.H.; Wriing review & ediing, Q.Y. Funding: This research received no exernal funding. Conflics Ineres: The auhors declares no conflic ineres. Appendix A P C = W L + Q [ 1 δ)k A + AI, I 1 ) ] Q 1 δ)k A P I +1 σ){[r k R ) + R b R )x 1 ]ψ 1 + R }N 1 A1) ω e Q + x 1 Q 1 )S 1 + T + R D 1 D [ P λ h = C hc 1 ) 1 βhe C 1 hc ) 1] A2) λ h W = χl ϕ Λ,+1 = λh +1 λ h β E Λ,+1 R +1 ) = 1 x = B /Q S ) A3) A4) A5) A6) µ s = E [Λ,+1 Ω +1 R k+1 R +1 )] A7) µ b = E [Λ,+1 Ω +1 R b+1 R +1 )] A8) υ = E [Λ,+1 Ω +1 R +1 ] Ω +1 = 1 σ) + σµ s+1 + x +1 µ b+1 )ψ +1 + υ +1 ) ψ = ψ = Q S N υ θ1 + x )ηx + κ) µ s + x µ b ) 1 2 x + µ s = η + κ µ b 4η + κ η + κ)/4η 2ηx + η + κ N = σ{[r k R ) + R b R )x 1 ]ψ 1 + R }N 1 + ω e Q + x 1 Q 1 )S 1 A9) A10) A11) A12) A13) A14)

22 Economies 2018, 6, ) α ) 1 α Y A = A K A L A A15) K A +1 = ξ +1S A16) 1 α) YA P A L A = W A A17) Z A = P A αa L A /K A ) 1 α A18) R k+1 = ZA δ)q +1 ξ Q +1 A19) ) λ B R b+1 + λ BB E β B λ+1 BB b+1 = 0 A20) P B 1 υ)y B = W B L B A21) ) 1 C B hc 1 B ) + E β B h C+1 B = P λ hcb BB A22) λ B mq+1 B + λbb υp B Y B ) ) Q B + E β B λ+1 BB QB +1 = 0 A23) Y B h = A h υ L B ) 1 ν A24) R b+1 B = mq B +1 h A25) P B Y B + B + Q B h 1 = P C B + W B L B + R b B 1 + Q B h A26) R b = R 1 + ) e ι [ ) 2 λ hn Q P 1 S I 2 I 1 1 S I λ hn I 1 I + βλ+1 hn Q +1 P S ) 2 I I +1 I 1 I 1 1 ) ] I 1 1 ) = 0 A27) A28) [ y = ω 1/ε y y Y A K A +1 = ξ +11 δ)k A + AI, I 1 ) A29) ) εy 1)/ε y ) ) ] 1/εy + 1 ωy Y B εy 1)/ε εy /ε y 1) y y ) 1/ε y Y A ) 1/εy = P A P ω 1/ε y y A30) A31) ) y ) 1/ε y Y B 1/εy P B = ) 1/εy A32) P 1 ω y P = [ ) 1 εyωy ) 1 εy P A + P B ) ] 1/1 ε y ) 1 ωy f = p Y + γλ, π ) γ pε 1 + π +1 ) ε f +1 z = Y + γλ, π ) γ p1 ε) 1 + π +1 ) ε 1 z +1 A33) A34) A35) Π = Π = µ f Π A36) z [ ] 1 γ)π ) 1 ε + γ Π γ p 1 ε 1/1 ε) 1) A37)

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