Does the Development of Money Market Funds in China Increase the Bank Liquidity Risk?

Abstract This paper studies the relationship between money market funds (MMFs) and bank liquidity risk in China. Based on the unique feature of "liquidity stratification" in China, the paper proposes a model of interbank market that includes big banks, small banks, and MMFs. The model drives that the emergence of MMFs pushes up the interbank liability ratio of the banking system and raises the bank liquidity risk. Using unbalanced bank-level panel data from China for the period from 2014 to 2021, we find that the empirical results are consistent with the theory. It is shown that the expansion of MMFs significantly elevates the bank liquidity risk in general, but this effect varies significantly by bank type, bank size, and different capital adequacy ratio. Moreover, the interbank liability channel plays an important mediating transmission role in the process of MMFs affecting bank liquidity risk. Keywords: Money market funds, Bank liquidity risk, Interbank liability channel.