Abstract
This study examines whether banks’ liability structure matters for their risk taking. Using a three-period model, we argue that a high deposit ratio lowers banks’ monitoring effort due to a low liquidity risk, causing banks’ risk taking to be greater. Taking the introduction of Macro Prudential Assessment (MPA) into China’s bank regulatory system in 2016 as a quasi-natural experiment, our difference-in-differences estimate shows that a reduction in wholesale funding increases bank risk as evidenced by higher risk-weighted assets, and this effect is more pronounced for banks with small market power, low capital requirement and high profitability. Further, increasing bank risk has a significant and positive impact on firms’ output growth through the lending channel, particularly for firms with greater business risk. Our findings provide a deep understanding of the link between banks’ funding liquidity and risk taking.
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