Abstract

This paper studies how monetary easing provides incentives for banks to take risk and issue mortgage-backed securities (MBS) and, because MBS have the "lemon" property, why MBS buyers are willing to purchase high-risk securities at high prices. Banks need equity to attract deposits. Monetary easing reduces this need, and banks leverage up and reduce their monitoring efforts. The internal need for liquidity and risk sharing motivates banks to issue MBS. Security buyers understand the moral hazard problem that banks face but are willing to purchase bank securities at high prices because monetary easing would also reduce their cost of funds.

Keyword

monetary policy ;  mortgage-backed securities ;  risk taking

Abstract

China’s annual economic growth has slowed since the global financial crisis, dropping from 14.2% in 2007 to 6.9% in 2017. The question as to whether China would fall into the middle-income trap (MIT) has attracted plenty of discussions. However, China is a diverse country with uneven economic development. Some provinces are far more advanced than others. Therefore, it might be inaccurate to look at China as one single entity to make a judgment on the MIT issue. Instead, looking into each province and comparing provincial-level differences would be more insightful. This case is essentially about economic growth and development in general, and that of China in particular. It makes the topic of growth more interesting by discussing the triggering factors of the MIT through comparing the differences between a “trapped” and an “escaped” province, i.e., Shaanxi and Jiangsu. To alleviate the regional development gap, Shaanxi and Jiangsu became paired poverty alleviation partners in 1996 under the guidance of the Chinese central government. However, more than 20 years have passed, yet there is still a huge gap between the two provinces in many fields. Jiangsu’s GDP per capita has surpassed the range of MIT, while Shaanxi’s has not and is very likely to be trapped with the continuing slowdown of its economic growth. The key difference between the two provinces is not their resources, but their development policies.

Keyword

China ;  Jiangsu ;  provincial comparision ;  Shaanxi ;  the Middle Income Trap

Abstract

This study investigates how heterogeneous firms choose their lenders when they raise external finance for Foreign Direct Investment (FDI) and how the choice of financing structure affects FDI activities. We establish an asymmetric information model to analyze why certain firms use private bank loans while others use public bonds to finance foreign production. The hidden information is the productivity shock to FDI. Banks are willing to monitor the risk of FDI, while bondholders are not; hence, banks act as a costly middleman that enables firms to avoid excessive risk. We show that firms’ productivity levels, the riskiness of FDI, and the relative costs of bank finance and bond finance are three key determinants of the firm’s financing choice. Countries with higher productivity, higher bank costs, or investment in less risky destinations, use more bond finance than bank finance. These results are supported by evidence from OECD countries.

Keyword

Bank finance ;  Bond finance ;  Foreign direct investment ;  Productivity ;  Risk