Markets

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

The Xi Jinping put is alive and well.

Late Saturday, the People's Bank of China said it will reduce the amount of cash reserves required for banks that engage in "inclusive financing," a new phrase for Beijing that refers to loans issued to farmers, small businesses, students and poverty-alleviation programs.

But let's call this "targeted" reserve ratio cut what it really is: Large-scale monetary loosening unseen since October 2015 that, according to China International Capital Corp., may unleash as much as 1 trillion yuan ($150 billion) of new liquidity. The real beneficiary? China's stock market.

According to the PBOC, banks with inclusive financing credits exceeding 1.5 percent of their existing advances or new loan issuance in 2017 can enjoy a 50-basis-point cut in their required reserve ratio. An additional 100 basis points will be lopped off if eligible lending reaches 10 percent or more of new advances in 2017.

The 1.5 percent threshold is far more lenient than previous targeted cuts. Based on the central bank's own estimates, pretty much the entire banking system will get this new treatment.

But why is the People's Bank loosening its purse strings now, when China's manufacturing sector is running at five-year high?

There's little evidence such targeted reserve ratio cuts work. Loan growth in the agricultural sector has been slowing even though China trimmed reserve ratios on farm loans seven times between 2014 and 2015. Shares of financial institutions Jiangsu Jiangyin Rural Commercial Bank Co. and Wuxi Rural Commercial Bank Co., which benefited from the policy changes, are down 9 percent and 16 percent respectively this year against a higher broader market.

Bet the Farm
Agricultural loan growth in China has slowed despite seven rounds of targeted bank reserve ratio cuts between 2014 and 2015
Source: PBOC

More likely, this is for show. In two weeks, Beijing will host the all-important 19th Party Congress, during which President Xi will announce his new cabinet for the next five years. The central bank wants to let ordinary Chinese know they're included in the recent economic rebound too.

Nonetheless, lower deposit reserve ratios are great news for China's struggling banks. Profit growth has stagnated since the PBOC slashed its benchmark one-year lending rate to 4.35 percent from 6 percent in 2015. In the first half, publicly traded lenders reported an average 6.8 percent rise in earnings.

China's banks are required to hold at least 15 percent of their deposits as reserves, by far the most among major economies. As a result, the nation's lenders trade at an average of only one-times book.

Banks want to lend, except they can't. The industry's loan-to-deposit ratio is edging close to 70 percent, the highest since data became available.

Where There's a Will
China's loan-to-deposit ratio is approaching 70 percent
Source: CBRC

The PBOC's latest move could be the next leg up for China's stock market. Spurred by improving corporate profits, the CSI 300 Index has rallied 16 percent since January to a two-year high. Yet banks, which constitute 17 percent of the benchmark, are laggards. Only well-capitalized blue chips such as Industrial & Commercial Bank of China Ltd., Bank of China Ltd. and China Merchants Bank Co. shine.

Financial Penalty
Chinese stocks would have done better had banks not been a drag
Source: Bloomberg

For now, let's not delve too deep into Beijing's motives. Suffice to say, so long as China's middle class sees a bull run in their share portfolios, they'll feel suitably content.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shuli Ren in Hong Kong at sren38@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net