China Retools Bank Reserve Ratio, Casting Doubt on RRR Cuts

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Understanding the Plunge in China’s Markets
  • Central bank planning new 'Macro Prudential Assessment' system
  • Officials look beyond reserve ratio for liquidity management

As investors continue to grapple with China’s economic slowdown, regulators may be taking away an old standby for monetary easing.

The required reserve ratio for commercial banks, a tool long used to add or remove liquidity, will increasingly be used instead as a lever for enforcing financial stability. That’s according to a People’s Bank of China announcement on Dec. 29 describing a new Macro Prudential Assessment system, or MPA.

The idea is to use the ratio of deposits that must be held at the PBOC as a method for reining in risks. Exposure to stock and bond markets will be used in calculating ratios for individual banks, the PBOC says. Officials will also look at growth in lending, rates on loans and capital adequacy.

Among the potential implications: less likelihood of required reserve ratio cuts as a way of stoking lending growth amid the weakest economic expansion in a quarter century. China’s main stock index tumbled so much on Monday that circuit breakers halted trading, offering a reminder of how poor sentiment is even after equities in recent months recouped some of last summer’s rout. The PBOC injected liquidity Tuesday through repurchase agreements, helping shore up some stabilization in stocks.

"We’ll see less across-the-board cuts" in the RRR, said Ming Ming, head of fixed income research at Citic Securities Co. in Beijing who formerly worked in the PBOC’s monetary policy division. "The MPA framework signals policy makers will move away from universal reserve ratio changes to being in favor of using the tool to fine-tune requirements for individual banks."

The change is part of a broader shift toward more flexibility with monetary policy tools as China tries to balance economic reforms with propping up growth. Central bank researchers have advocated setting up an interest-rate target similar to what the U.S. Federal Reserve has used.

Ma Jun, the chief economist of the PBOC’s research bureau, said in a commentary last Wednesday the central bank should set reserve requirements with short-term interest rate stability in mind and pointed to open market operations and other facilities to manage rates. China’s 10-year bonds dropped the most in two weeks after Ma’s comments damped speculation that lenders’ required-reserve ratios will be eased further.

The required-reserve ratio forces banks to put aside a percentage of their deposits that they can’t lend out, which directly affects the cash supply in the banking system. It’s a monetary tool that the U.S. Federal Reserve has long since stopped using to adjust liquidity in the economy. The PBOC currently pays a 1.62 percent annual interest rate on banks’ required reserves and 0.72 percent on extra reserves parked at the central bank.

October Cuts

Chinese policy makers last announced a cut in the ratio for the biggest banks in October, reducing it to 17.5 percent from 18 percent, while also lowering the one-year lending rate, their main policy tool, to a record low 4.35 percent. In a series of reductions, the central bank has brought the reserve ratio down from its 2011 peak of 21.5 percent.

The easing underscored the determination of the country’s leaders to meet their 2015 growth goal of about 7 percent. The pace of expansion will slow to 6.5 percent in 2016 and 6.3 percent in 2017, according to the median estimates of economists surveyed by Bloomberg.

Liquidity Concern

Market participants say short-term liquidity is tightening and capital outflows continue, making the PBOC more likely to add liquidity, according to a report Tuesday by the official China Securities Journal, an affiliate of Xinhua News Agency. The participants, who weren’t identified, said additional RRR cuts are necessary and feasible, the paper said. Economists had expected one more RRR cut by Jan. 1, according to the median of estimates in a Dec. 17 to Dec. 22 Bloomberg survey.

The central bank said in its announcement last week it will use the new MPA system to examine banks’ capital adequacy and watch financial institutions’ interest-rate pricing, the monetary authority said last week. The PBOC will assess data quarterly, while monitoring and giving guidance to banks on a monthly basis.

The PBOC said the assessment “will change its focus from loans, which are narrowly defined, to a focus on credit in a broader sense.” It will include bond investments, equity investments and buybacks of financial assets sold -- which typically refers to banks’ off-balance-sheet assets.

Regulatory Reforms

"Introducing MPA in China sets the stage for the forthcoming reform of the financial supervision system," Mao Junhua, an analyst at China International Capital Corp. in Beijing, wrote in a report. The upgraded mechanism will give the PBOC "more macro-prudential regulatory powers," he said.

China’s top leaders, looking for new ways to steer the economy, said last month that monetary policy must be more “flexible” to create appropriate conditions for structural reform.

The central bank has applied different required-reserve ratios for different loan types. In the last four publicly announced RRR cuts, PBOC cut the level for some lenders by an additional 0.5 percentage point if they allowed more lending to rural areas and smaller businesses. That’s means the real RRR applied to certain banks could be as much as 1.5 percentage point lower than the standard rate. 

Customized RRR

Ming at Citic cited comments by the PBOC’s Ma as further evidence that there will more customized RRR adjustments and fewer across-the-board changes. In his commentary in the PBOC-published newspaper Financial News, Ma said the central bank should strengthen guidance of market interest rates to help the economy. Ma also reiterated the idea of setting and managing an interest-rate corridor target.

The PBOC’s initiative may be a response to a lack of coordination by financial regulators after Chinese stocks plunged last year and a surprise devaluation of the yuan, and may be a signal of coming reform to the nation’s financial regulatory structure, according to Xia Le, an economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong.

The "PBOC has traditionally been a stronger proponent for reforms" compared with the China Banking Regulatory Commission and the China Securities Regulatory Commission, Xia wrote in a note. "This could be good news for financial reforms in China."

— With assistance by Zheng Wu, Jun Luo, and Kevin Hamlin

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