PBOC Seeks to Optimise Liquidity Structure by Cutting Required Reserve Ratio in Lieu of OMO

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The Chinese central bank has emphasised that its use of targeted cuts to the required reserve ratio has the goal of optimising the banking system’s liquidity structure.

The People’s Bank of China (PBOC) announced on 7 October that it would cut the required reserve ratio for the fourth time this year on 15 October, with a 100 basis point reduction for large-scale commercial banks, share-controlled commercial banks, municipal commercial banks and foreign-invested banks.

The announcement arrived just after the US Fed unveiled a third interest rate hike for 2018 at the end of September, as well as amidst unabating trade tensions between China and the US.

According to PBOC the move is intended to “further support the growth of the real economy, optimise the liquidity structure of commercial banks and financial markets, reduce financing costs, and guide financial institutions to continue to expand the vigour of support for small and micro-enterprises, private enterprise and innovative enterprise.”

Analysts point out that the use of a reserve ratio cut as opposed to the roll over of medium-term lending facilities (MLF) by PBOC will bring greater stability to long-term liquidity.

“This 1 percentage point reduction will release approximately 1.2 trillion yuan, of which 450 billion yuan will offset maturing MLF,” said Wen Bin (温彬), chief researcher at China Minsheng Bank, to state media.

“The other 750 billion yuan will offset tax payments, and for this reason will be of benefit to optimising the liquidity structure under the precondition that overall liquidity volumes remain comparatively stable.”

An official from PBOC that the main goal of the reserve ratio cut is optimisation of the liquidity structure, given that recent lending growth has lifted the medium and long-term liquidity needs of Chinese financial institutions.

According to the official an appropriate reduction in the required reserve ratio and the swapping out of some funds lent by the central bank can further increase the stability of banking sector funds and optimise the liquidity structure of commercial banks and financial markets, as well as reduce bank financing costs and thus financing costs for enterprises.

PBOC also indicated that the cut does not signal a turn around in monetary policy.

“The current cut is still a targeted adjustment, and overall banking system liquidity will be fundamentally stable,” said an official. “The monetary situation is stable and neutral, and the direction of monetary policy remains unchanged.”

“In the near future monetary policy is likely to remain stable and maintain rationally ample macro-liquidity, as opposed to excessive irrigation” said Lian Ping (连平), chief analyst at Bank of Communications.

Lian Ping expects the cut to have limited impact on the Chinese exchange rate, given that the net liquidity increase will be trimmed by maturing MLF and not result in interest rate declines.

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