China's lending market faces a significant challenge: the demand for loans is outpacing the supply, leading to a critical imbalance that hinders economic growth and financial stability. This article explores the factors contributing to this imbalance and proposes regulatory changes to address the issue without compromising stability.



Factors Contributing to the Supply-Demand Imbalance

1. Policy Shocks and Loan Supply Dynamics: Monetary policy shocks in China can lead to supply-demand imbalances in the loan market. Market-based monetary policy measures, such as changes in benchmark rates and reserve requirements, influence the supply of bank loans, amplifying the effects on the economy (Bernanke & Blinder, 1988; Bernanke & Gertler, 1995; Disyatat, 2011; Kishan & Opiela, 2012). In China, these policy shocks account for up to 20% of the forecast variance of output after two years, with loan supply dynamics contributing to at least 60% of the overall effects on output (Chen et al., 2017; Fernald et al., 2014; Kamber & Mohanty, 2018).
2. Banking Deregulation: The partial deregulation of China's banking sector in 2009 allowed joint equity banks to open new branches and extend loans to enterprises previously overlooked by state-owned banks. This deregulation led to an increase in the number of joint equity bank branches in deregulated cities by 8.6% within two years (Gao et al., 2023). However, this expansion was not evenly distributed, leading to supply-demand imbalances in certain regions.
3. Lending Preferences: New joint equity banks initially favored lending to state-owned enterprises (SOEs) due to their perceived lower risk and implicit government backing. This preference led to an increase in lending to SOEs by 39.3% in deregulated cities in the first year following deregulation (Gao et al., 2023). However, this bias diminished over time as banks improved their ability to assess the creditworthiness of private firms.
4. Credit Supply Effects: The credit supply channel of monetary policy is an important and economically relevant transmission channel for monetary policy in China. It takes roughly one year for banks to adjust their lending strategies and for loan supply effects to unfold completely (Chen et al., 2017; Fernald et al., 2014; Kamber & Mohanty, 2018). This lag in adjustment can contribute to supply-demand imbalances in the loan market.



Regulatory Changes to Facilitate More Lending Without Compromising Stability

To facilitate more lending without compromising stability, the following regulatory changes could be considered in China:

1. Improved Risk Assessment and Management:
* Enhance the ability of financial institutions to assess the creditworthiness of borrowers, especially private firms and small and medium-sized enterprises (SMEs). This can be achieved by promoting the use of advanced analytics and data-driven approaches to lending decisions.
* Strengthen risk management practices, including stress testing and provisioning requirements, to ensure that banks are better equipped to handle potential defaults and economic downturns.
2. Increased Transparency and Disclosure:
* Encourage greater transparency in the lending process, including the disclosure of loan terms, conditions, and collateral requirements. This can help borrowers make more informed decisions and reduce the risk of mis-selling or predatory lending.
* Promote the sharing of credit information and data among financial institutions to improve the accuracy of credit assessments and reduce the risk of overborrowing or fraud.
3. Targeted Lending to Support Key Sectors:
* Encourage banks to lend more to strategic sectors, such as manufacturing, technological innovation, and rural development, by providing incentives or preferential treatment for loans in these areas.
* Offer targeted support to SMEs and private firms, such as lower interest rates or longer repayment periods, to help them access the financing they need to grow and create jobs.
4. Prudential Regulation and Capital Adequacy:
* Ensure that banks maintain adequate capital buffers to absorb potential losses from defaults or economic downturns. This can be achieved by strengthening capital adequacy requirements and encouraging banks to hold more high-quality capital.
* Implement macroprudential measures, such as countercyclical capital buffers or sector-specific capital requirements, to address systemic risks and prevent excessive credit growth.
5. Enhanced Financial Education and Literacy:
* Promote financial education and literacy among borrowers to help them understand the risks and responsibilities associated with taking on debt.
* Encourage banks to provide borrowers with clear and concise information about loan terms, conditions, and repayment obligations to help them make informed decisions.
6. Strengthening the Legal Framework for Lending and Enforcement:
* Enhance the legal framework for lending, including the enforcement of contracts and the protection of creditors' rights.
* Strengthen the legal framework for insolvency and bankruptcy to ensure that borrowers have a fair and transparent process for resolving their debts and that creditors are treated fairly.

By implementing these regulatory changes, China can facilitate more lending while maintaining financial stability and promoting sustainable economic growth. Addressing the supply-demand imbalance in the lending market is crucial for supporting the country's economic development and ensuring the well-being of its citizens.