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This paper comparatively examines the bank-lending channel of monetary policy transmission in China between Chinese and foreign banks. We consider 22 foreign banks and 67 domestic banks that account for about 82-88% of total bank assets in China. We focus on the period 2007-2013 during which foreign banks in China had dramatically increased, following the liberalization of the entry of foreign banks at the end of 2006. In our models, we allow for heterogeneity in banks’ characteristics such as size, capitalization, liquidity, credit risk and efficiency. Using a fixed effect model, we find that bank ownership plays a critical role in determining bank’s response to monetary policy. In specific, foreign banks are found to be less sensitive to China’s monetary policy than Chinese banks, but they are sensitive to the real interest rate of U.S. This finding points to the existence of internal capital markets in case of foreign banks. Foreign banks can use internal capital market to buffer the impact of monetary policy on loans. As a result, they could reduce their loans by less than Chinese banks in response to tight monetary policy. When the Chinese monetary authority conducts monetary policies, therefore, it should keep in mind that larger changes in monetary policy instruments are required to obtain the same desired change in aggregate demand in the presence of the buffering effects of foreign banks. We also find that the effects of price instruments and quantitative instruments of monetary policy on Chinese banks’ lending behavior are different. For example, Chinese banks’ lending is more sensitive to policy lending rate than to required reserve ratio.
