China’s monetary authority eased liquidity tensions in the banking system when the innovative capital injection measures took effect on April 25, which will not change the regulator’s determination in the long-term goal of financial deleveraging in a tightening regulatory environment.
A net 400 billion yuan ($63.32 billion) was released on April 25 from the central bank’s reserve of commercial banks’ deposits, with another freeing of 900 billion yuan to erase lenders’ liability to the central bank through the Medium-term Lending Facility (MLF).
This monetary policy operation — a reduction of the reserve requirement ratio (RRR) by 1 percentage point but in an innovative way, is expected to supplement liquidity especially for small and medium-sized banks without making overall monetary policy too loose, according to experts.
The People’s Bank of China, the central bank, announced the measure on April 17 when the country’s money market rates have risen sharply following tighter regulatory constraints.
Liquidity injection through the RRR cut is sufficient to offset the fund tightening after the central bank drew back net 150 billion yuan lending to commercial banks on the same day, without any further open market operations, according to a statement on the PBOC website on April 25.
After the move took effect, the 10-year government bonds’ yield retreated two basis points to 3.5870 percent, ending a consecutive rise of five trading days since April 18. The seven-day repo rate, a new gauge which could better reflect the country’s money market interest rate level, dropped to 2.99 percent down from 3.04 percent a day earlier.
The central bank said later that the liquidity increase could offset the large amount of cash withdrawals by corporations to pay taxes in mid-April, and the liquidity situation in banking system remained nearly unchanged.
“The RRR cut to repay MLF could optimize the liquidity structure, leading financial institutions to increase lending to small and micro enterprises,” said the central bank, highlighting that it will evaluate the results in the coming three quarters under a macro-prudential assessment framework.
Liang Hong, chief economist of the China International Capital Corporation, recently wrote in a research note that the decrease in banks’ reserved cash “doesn’t go against financial deleveraging as a long-term target”.
Instead, she said, it will primarily discourage financial institutions’ motivation to develop shadow banking business, a key reason that has facilitated the credit boom and elevated leverage when cash-starved lenders select short-term and little-regulated risky investment vehicles.
Signals have shown that “a more ambitious deleveraging process is possible in the coming months”, including the impending debut of the “strictest” asset management regulation, which requires more available capital in commercial banks to reduce vulnerabilities, said Wei Wei, an analyst with Ping An Securities.
Some market watchers speculated that the central bank may further cut the ratio this year, as that for big banks — at 16 percent right now down from a peak of 21 percent in 2011, remains the highest in any major economy.
Bloomberg economists Tom Orlik and Fielding Chen said the RRR cut could further lower funding cost of commercial banks when they borrow from the central bank, and that “will ultimately be passed through to corporate and household borrowers”.
They saw the adjustment as liquidity management measure, not a shift in the current “prudent and neutral” monetary policy stance.