How does financial development change the effect of the bank lending channel of monetary policy in developing countries?- Evidence from China

This study investigates the relationship between financial development (FD) and monetary policy effectiveness in developing countries using China as a case. The traditional view argues that the relationship between FD and the role of the bank lending channel (BLC) of monetary policy has an inverted U shape. However, in this study, we find that this may not be the case. The results depend on how the types of FD indicators are classified. For developing countries such as China, financial reform does not necessarily improve the financial marketization level. Therefore, FD produces two effects: the market-oriented effect (FDM) and scale effect (FDS). The effect of the former is an inverted U-shape while that of the latter is a U-shape. Previous studies mainly focused on FDM thus ignoring FDS. In our, study, we find that the relationship between FD and the role of BLC is affected by the heterogeneity of enterprises.