Why did China’s banking system grow so much since 2000 if the PBOC was actively increasing the RRR and withdrawing liquidity through FX Reserve purchases?
First of all, I want to make it clear that, when a central bank increases its FX reserves, it supplies local currencies and increases liquidity in the money market. But this is certainly not the reason that China’s banking system grew so much. Secondly, I believe that the main reason is during the marketization process of the real economy, the Chinese government kept the monopoly power of the banking system. In fact, the interest rates of deposit and loan were not determined by the market. The banking system had very high spread between loan and deposit rates. Since the real economy grew so fast since 2000, the banking system expanded as expected. The increasing of the reserve requirement rate had small effect to the banking system since the banks rely more on financing products, which are off the balance sheet. Finally, I think government's control of the banking system is risky as the monopoly banks provide too much money to the real estate development instead of to the innovative firms since they don’t care about the risk and return structure of their loan projects.