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| Leverage Structure, Level and Financial Stability: Theory and Empirics |
| JI Min, YAN Baoyu, LI Hongjin
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| Research Bureau / Operations Office(Beijing),the People’s Bank of China |
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Abstract In this article, we analyzed China’s leverage issue, focusing on the level and structure of financial leverage and its relationship with financial risks, we found that the different trends between micro leverage ratios and macro leverage ratios mainly reflect the change of return on capital, which is in turn driven by the economic cycle. Our micro analysis based on the MM theorem shows that information and transaction costs, taxation, and incentive mechanisms, such as the soft budget constraint, are closely related to the leverage structure. Our macro analysis indicates that the investment-oriented growth pattern with high savings helps explain the high leverage ratio in China. We believe that the process of de-leverage should be managed prudently, i.e., efforts should be made to avoid a liquidity crisis and a “debt-deflation” trap due to rapid de-leveraging, and to avoid asset bubbles due to a rapid increase in leverage. At the same time, the best choice for leverage formation mechanism is market-oriented rather than government decided to improve the efficiency of leverage utilization.
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Received: 01 November 2016
Published: 18 January 2018
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