The editor of one of China’s leading financial publications says the central bank’s decision to use macro prudential policy in tandem with monetary policy to attend to both the financial sector and the real economy marks a major turning point for the country’s regulatory efforts.
While the China Banking Regulatory Commission and the People’s Bank of China have led a concerted deleveraging campaign since the start of the year as part of efforts to stymie systemic financial risk, recent actions would appear to contradict their avowed intentions.
PBOC’s recent decision to inject 498 billion yuan into the Chinese economy via medium-term lending facilities triggered wide spread discussion within domestic financial circles, with many analysts interpreting it as a “moderation” of deleveraging policy.
According to Caixin chief editor Hu Shuli, while the decision may appear “contradictory” in light of the ongoing deleveraging push by regulators, it actually indicates that the central bank has transitioned towards the use of “two pillars” of monetary policy and macro prudential policy to maintain economic stability and ensure a more safe and orderly deleveraging.
In its “2016 Q4 China Monetary Policy Implementation Report” released in February PBOC confirmed that it would explore the use of a financial control framework consisting of the two pillars of monetary policy and macro prudential policy.
According to Hu, the addition of macro prudential policy to monetary policy as part of PBOC’s policy tool kit is a critical reform that gives the central bank greater flexibility and discretion when it comes to regulation of the financial sector.
While monetary policy will still primarily be used to manage aggregate demand and the Chinese macroeconomy, with a view to stabilising growth and inflation, macro prudential policy can be directly applied to the financial system itself, in order to control excess deleveraging or pro-cyclical credit expansion, with the goal of maintaining financial stability.
“Based on the temperature of the macroeconomy and the level of financial institution leverage, the two can be coordinated in multiple combinations, both loosely and tightly, but alway with the goal of preventing systemic financial risk and raising the ability of the financial sector to service the real economy,” writes Hu.
The great flexibility and discretion that this two prong approach provides could prove vital for effective regulation of the financial sector and economy in future.
This is particularly the case when attempting to deal with a divergence in the cycles in the real economy and the financial, such as that which currently confronts Chinese policymaker.
Hu notes that recent fall in Caixin’s PMI indicating that China’s real economy is on a downward trek, necessitating the maintenance of stable, neutral monetary policy without any undue tightening.
At the same time, however, the high debt levels of corporations and financial institutions and attendant risk accumulation means that regulators must stay the course when it comes to fiscal deleveraging, and refrain from undue loosening of monetary policy.
Under such circumstances the use of macro prudential policies to rein in financial institutions gives regulators greater leeway to tinker with monetary policy in the service of the real economy.
“In strategic terms, the central bank must closely pay attention to the deleveraging of the financial system, and the impact of rises in market capital rates on the cost of financing in the real economy for things like corporate bonds and loans, as well as ensure that the money supply satisfies macroeconomic growth needs,” writes Hu.
“At the same time, by means of macro-prudential assessment [the central bank can] strengthen restraints on the conductor banks, and match the pace of broad credit extension by banks with their respective credit levels.”
According to Hu because the new two pillar policy implemented by PBOC is new, the MPA system must be “continually improved…and promptly and flexibly adjusted,” as evidenced by the central bank’s decision since 2016 to incorporate cross-sector risk and off balance sheet wealth management products into MPA’s, as well as real estate loans in some cities where housing prices are rising rapidly.
“An emphasis on macro prudential [policies] is a major trend in international financial regulation,” writes Hu. “As early as 2010 central bank governor Zhou Xiaochuan pointed out that the big lesson of the international financial crisis was that you cannot focus solely on risk prevention for individual financial institutions or sectors, but need to prevent financial risk from a systemic perspective.
Hu recently wrote about the need for regulators to exercise caution during the process of deleveraging, in order to avert a credit or liquidity crunch which could itself become a source of systemic risk.