Is PBOC Reviving Use of Reserve Ratio Adjustments as Liquidity Management Tool?

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Wang Tao (汪涛), chief economist for UBS China, says that Beijing’s recent decision to reduce the reserve ratio requirement for some Chinese lenders is intended to restore the use of such adjustments as a liquidity management tool, and does not mark a departure from the prevailing theme of monetary policy.

The People’s Bank of China (PBOC) recently announced that it will reduce the reserve ratio requirement for a range of lenders by 1 percentage point starting from 25 April, including large-scale commercial banks, joint-stock banks, municipal commercial banks, non-county village commercial banks and foreign-invested banks.

The reduction is expected to unleash 1.3 trillion yuan in liquidity, of which 900 billion yuan will be used to repay the medium-term lending facilities (MLF)  borrowed by lenders  from PBOC as part of the latter’s open market operations.

Most of the remaining 4 billion yuan will be allocated to municipal commercial banks and non-county rural commercial banks.

In an opinion piece written for Sina on the reserve ratio reduction, UBS’s Wang Tao says that it will serve to cut the debt costs of banks, and thus reduce financing costs for companies.

“Compared to other liquidity management methods (such as MLF) for banks that entail the payment of interest, reserve ratio reductions are extremely low cost from the perspective of lenders.

“For example, at present the interest rate for a one-year MLF is 3.3%…we calculate that using the reserve ratio reduction to swap out maturing MLF (900 billion yuan) can save banks 29 billion yuan in funding costs (annualised).”

This reduction in costs will in turn provide ample room for reducing the borrowing costs of some commercial enterprises, with the Chinese central bank indicating that the reserve ratio cut is part of efforts the shore up financial inclusion.

PBOC has required that financial institutions use the funds released by the reserve ratio reduction to make loans to micro-enterprises, who would otherwise struggle to obtain credit in China’s bank-dominated finance system.

 

Tao believes that the reserve ratio reduction does not mark a shift in overall settings for monetary or financial policy.

“The central bank has stated repeatedly that stable and neutral monetary policy will remain unchanged, as well as emphasised that the capital unleashed by this reserve ratio reduction will primarily be used to repay maturing MLF.

“In addition to this, the central bank has also emphasised that in order to prevent financial risk, it will continue to maintain a ‘comparatively high’ reserve ratio.

“We believe that the central bank’s current reserve reduction is mainly for the normalisation of liquidity management tools, as well as reducing the cost of funds for banks.

“In fact, we believe that with the targeted reserve reduction (effective as of January this year) previously implemented by the central bank, and this subsequent reserve reduction, the central bank is already engaging in foreshadowing, with the goal of making reserve ratio adjustments once again serve as a normalised liquidity management tool (and isn’t a strong signal of policy loosening.)

Tao further points out that the reserve reduction will be of benefit to shrinking the negative impacts on banks of Beijing’s beefed up financial regulation and crackdown on shadow banking.

According to Tao helping Chinese banks to expand the scope of their lending will help to mitigate the impact of curbs on their shadow banking activities.

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