The official news publication of the Chinese central bank has signalled a more rapid shift in its policy framework from quantitative tools towards pricing-based adjustments, as well as a “twin-pillar framework” that puts equal emphasis upon macro-prudential policy.
An article by Zhou Yan (周琰) published by the People’s Bank of China’s Financial News entitled “Monetary Policy Framework Accelerates Transition, Exploring the Establishment of a Twin Pillar Adjustment Framework” (货币政策框架加速转型，探索建立双支柱调控框架), points to the future use of macro-prudential assessments as one of the “twin pillars” of Chinese central banking policy, given its rise to prominence around the world since the Great Financial Crisis.
“People’s Bank of China vice-governor Yi Gang has said that the twin pillars refer to monetary policy and macro-prudential policy,” writes Zhou.
“Prior to the Great Financial Crisis, mainstream central banking policy frameworks had monetary policy at their core and price stabilisation as their policy goal, playing a very strong role in forestalling high inflation.
“However, the Great Financial Crisis clearly indicates that price stability does not mean financial stability.
“Prior to the crisis US prices were stable, yet financial asset prices greatly increased, and market behaviour was distinctly pro-cylical, while cross-market risk transmission was strong.
“For this reason, solely relying on monetary policy to maintain financial system stability is insufficient… the main source of financial system risk is financial pro-cycliality and cross-market risk transmission, and macro-prudential policy is an ‘apt drug.'”
According to Yi Gang the establishment of a twin pillar policy framework will serve two function – it will preserve the stability of the Chinese currency, while maintaining the stability of the financial system.
For this reason “China long ago began to explore the implementation of methods combining monetary policy and macro-prudential policy, on the one hand actively and appropriately advancing the transition in the monetary policy adjustment framework from a quantitative model to a price-based model and innovating.”
China’s macro-prudential framework involves three main components, the first being the launch of the differentiated deposit reserve adjustment system 2011, requiring that financial institutions “with large amounts of money do large amounts of business.’
2016 saw the upgrading of the system into the macro-prudential assessment system, which applied curbs on financial institutions in seven key areas in order to achieve counter-cylical adjustments.
The second component involves the incorporation of cross-border capital flows into the MPA, while the third will see the continued strengthen real-estate market macro-prudential management, with the formation of differentiated housing credit policies that will vary by city.
Zhou further points out that with respect to the monetary policy side of the central bank’s policy framework, China is currently making the shift from adjustments via conventional quantitative tools towards adjustments via pricing-based means.
“The central bank continually engages in innovation of its adjustment methods and promotes shifts in the monetary policy framework,” writes Zhou.
“The central bank’s use of monetary policy tools such as pledged supplementary lending (PSL) and medium-term lending facilities (MLF) supports the expansion of credit provision by financial institutions to key areas and weak links in the national economy, advancing reductions in financing costs and increases in financial efficiency, as well as driving the financial system to better service the real economy ands upgrades in the economic structure.”
Zhou cites Liang Hong, chief economist of China International Capital Corporation, on the matter of how changes in the Chinese economy necessitate a shift in monetary policy.
“At present the Chinese economy and Chinese finance are changing profoundly, and the uncertainty of monetary demand is increasing,” said Liang.
“Both the supply and demand side of finance need a shift in the monetary policy framework from quantitative tools towards a price-based model.
“Looking at bank liabilities, the rapid growth in bank wealth management products and interbank borrowing has expanded the disparity between total bank liabilities and M2 growth over the past two years.
“Looking at bank assets, rapid growth in operations such as fund outsourcing has continually increased the creditor’s rights of banks with respect to other financial institutions, as well as amassed huge off-balance sheet assets.
“Non-bank financial institutions and the development of financial innovation has made it more and more difficult for quantitative indices such as M2, loans and social financing to fully reflect financial conditions, as well as made them difficult to control.”
According to Zhou Yan, this drive towards a price-based adjustment mechanism is evidenced by PBOC’s reform of interest rates, which will compel China to follow of central banking practices of advanced economies as well as expand its portfolio of policy tools.
“Over the past two years, China has basically completed the marketisation of interest rates,” said Zhou.
“Money market rates are the necessary means for influencing long-term interest rates, but China’s money market rate term structures are still incomplete.
“Following changes to monetary adjustment methods, we are now actively proceeding with the selection of interest rate transmission mechanisms – in June 2015, the central bank introduced large-volume certificates of deposits, and in October 2015, started to issue 3-month sovereign bonds.
“Industry experts believe that these measures will enrich the selection of money market tools, and help to increase the completeness and effectiveness of the benchmark yield curve, expediting the transmission of monetary policy.
“Additionally the expansion of the bond market and declines in reserve ratios will be of benefit to the effective transmission of policy signals to bond rates and lending rates.”