Within the banking sector itself, although it is still dominated by majority-state owned big five"banks which hold about 47%o of industry assets and roughly the same share of total deposits in the sector, contestability of the sector has also increased (PBC FSr Report, 2012). Admittedly, bank competition is to a significant extent constrained by relatively high entry barriers and interest rate regulation The existing literature on the efficiency of the Chinese banking sector has mixed findings Banks undergoing a foreign acquisition or public listing are found to have better pre event performance, but little performance changes were recorded after changes of ownership(Lin and Zhang, 2009). On the other hand, there is evidence that the Chinese banking system has benefited from the entry of foreign investors through higher profitability and incr reased efficiency in the banking system( Garcia-Herrero and Santabarbara, 2008). City commercial banks were found to outperform state-owned commercial banks, suggesting diversity in terms of ownership is key to better banking in China(ferri, 2009). Changes in ownership also has an impact on the lending behavior of banks, as lending by state-owned banks were found to be less prudent than lending by joint-Stock banks Jia, 2007) However, the benefits and efficiency improvements are not distributed evenly across banks and lenders. Smaller, less-regulated financial institutions appear more commercially oriented and gained more market shares in some areas after the reforms (Podpiera, 2006). Higher contestability in the banking sector helps alleviate financing constraints for small and medium enterprises( Chong et al., 2012). Joint-stock banks and city commercial banks were also found to have gained higher total factor productivity growth than state-owned banks in recent years( Chang et al, 2012) 3. A Stylized Model on Dual-Track Interest Rates System The setting of the model is similar to the framework in Chen et al. (201 1)and He and Wang(2012), which extend the model developed in Freixas and Rochet(2008). As in He and wang(2012), we introduce a dual-track interest rates system and focus on fund flows between the regulated banking system(the first track) and non-regulated money and bond market(the second track). In the banking sector, the central bank influence bank lending using the benchmark deposit rate and the rrr. In addition, bank lending can be affected by changes in the market price of funds due to arbitrage between the banking sector and capital markets. In this sense, the market price of funds in the money and bond markets is a shadow price to bank lending. In contrast to He and Wang(2012) which focuses on how monetary policy changes affect market interest rates, the new model in this paper pays more attention to how monetary policy and market interest rate affect both the price and quantity of bank lending. In order The"big five"banks are Industry and Commercial bank of China(ICBc), Bank of China(boc) Construction Bank of China(CBC), Agricultural Bank of China(ABC) and Bank of Communications BOCOM)6 Within the banking sector itself, although it is still dominated by majority-state owned “big five” banks which hold about 47% of industry assets and roughly the same share of total deposits in the sector, contestability of the sector has also increased (PBC FSR Report, 2012).4 Admittedly, bank competition is to a significant extent constrained by relatively high entry barriers and interest rate regulation. The existing literature on the efficiency of the Chinese banking sector has mixed findings. Banks undergoing a foreign acquisition or public listing are found to have better pre￾event performance, but little performance changes were recorded after changes of ownership (Lin and Zhang, 2009). On the other hand, there is evidence that the Chinese banking system has benefited from the entry of foreign investors through higher profitability and increased efficiency in the banking system (Garcia-Herrero and Santabarbara, 2008). City commercial banks were found to outperform state-owned commercial banks, suggesting diversity in terms of ownership is key to better banking in China (Ferri, 2009). Changes in ownership also has an impact on the lending behavior of banks, as lending by state-owned banks were found to be less prudent than lending by joint-stock banks (Jia, 2007). However, the benefits and efficiency improvements are not distributed evenly across banks and lenders. Smaller, less-regulated financial institutions appear more commercially oriented and gained more market shares in some areas after the reforms (Podpiera, 2006). Higher contestability in the banking sector helps alleviate financing constraints for small and medium enterprises (Chong et al., 2012). Joint-stock banks and city commercial banks were also found to have gained higher total factor productivity growth than state-owned banks in recent years (Chang et al., 2012). 3. A Stylized Model on Dual-Track Interest Rates System The setting of the model is similar to the framework in Chen et al. (2011) and He and Wang (2012), which extend the model developed in Freixas and Rochet (2008). As in He and Wang (2012), we introduce a dual-track interest rates system and focus on fund flows between the regulated banking system (the first track) and non-regulated money and bond market (the second track). In the banking sector, the central bank influence bank lending using the benchmark deposit rate and the RRR. In addition, bank lending can be affected by changes in the market price of funds due to arbitrage between the banking sector and capital markets. In this sense, the market price of funds in the money and bond markets is a shadow price to bank lending. In contrast to He and Wang (2012) which focuses on how monetary policy changes affect market interest rates, the new model in this paper pays more attention to how monetary policy and market interest rate affect both the price and quantity of bank lending. In order 4 The “big five” banks are Industry and Commercial bank of China (ICBC), Bank of China(BOC), Construction Bank of China(CBC), Agricultural Bank of China(ABC) and Bank of Communications (BOCOM)