Deregulation and bank stability: Evidence from loan-to-deposit ratio requirement in China

Abstract

This paper examines the impact of financial deregulation, specifically, the removal of China's loan-to-deposit ratio (LDR) cap in 2015, on bank stability. We show that LDR deregulation strengthens the stability of LDR-constrained banks through three mechanisms. First, it alleviates competition for deposits, allowing banks to enhance their franchise value. Second, it enables banks to issue more long-term loans, supported by a more diversified funding base. Third, it reduces reliance on off-balance-sheet activities, such as principal-floating wealth management products, thereby lowering exposure to shadow banking risks. Collectively, these changes reinforce banks' maturity transformation abilities, ultimately improving their overall stability.