Declining Excess Reserve Ratio Does Not Signal Loose Monetary Policy: PBOC


China’s central bank has indicated that ongoing declines in the excess reserve ratio do not signal a shift in monetary policy or plans to ease banking system liquidity.

In the Chinese banking system excess reserves are those funds deposited by financial institutions with PBOC that are in excess of statutory reserve requirements, and are primarily used for payment and settlement or financial institution transfers.

According to Caixin the excess reserve ratio is the percentage of excess deposit reserves to standard deposits, and is a key component of the base money supply as well as the most liquid asset of Chinese financial institutions.

The volume and ratio of excess reserve deposits is extremely important for financial institutions, as it serves as a key indicator of liquidity.

China’s excess reserve ratios have seen a continuous decline since the turn of the century, from over 7% in 2001 to an average of around 3.5% during the period from 2003 to 2008, to around 1.5% at present.

The People’s Bank of China has just indicated, however, that these declining ratios do not portend a shift in its monetary policy setting, but are instead a response to ongoing changes in the Chinese payments system and banking system.

On 11 August PBOC issued its “2017 Second Quarter China Monetary Policy Execution Report” (2017年第二季度中国货币政策执行报告), in which is stated that advances in China’s payments system have greatly reduced the time needed for funds settlement, and essentially expunged “friction” during the transfer process.

This has in turn reduced the time and cost of funds remittance as well as transaction costs during the process of converting disparate assets in excess reserves.

The rapid development of Chinese financial markets have also made is easier for commercial banks to access various fundings channels, in order to inject capital when required and reduce the need for precautionary measures.

According to the PBOC report China’s commercial banks have also made strides when it comes to liquidity management, enabling them to better predict factors impacting liquidity, keep excess reserves at a minimum and shore up their capital efficiency.

The report states that PBOC has taken pains to improve its monetary policy operating framework in recent years, which has also abetted a marked reduction in the need for excess reserves.

PBOC further notes that it’s imprudent to make facile comparisons of excess reserve ratios at different points in time, given that they are subject to high levels of intra-month as well as seasonal fluctuation, contingent upon factors such as regulatory assessments, fiscal expenditures and shifting deposit levels.

While excess reserve ratios tend to rise towards the middle and end of the year, once key seasonal factors lose their influence they are wont to fall markedly.