China offers stimulus by lowering bank reserve requirements

BOFIT Viikkokatsaus / BOFIT Weekly Review 2015/17

​On Monday (Apr. 20), the People’s Bank of China lowered the reserve requirement ratio (RRR) by a full percentage point. The RRR requirements of large banks fell to 18.5 % and to 15–16.5 % for other credit institutions. The PBoC has begun to apply the reserve requirement ratio as a targeted policy tool, granting reduced RRRs to certain banks (e.g. those focused on serving small businesses and farm lending). The RRR can even be bank-specific. RRR represents the amount of a bank’s deposits held by the central bank. A higher RRR reduces the bank’s ability to lend.

In the absence of a functional interest-rate system, the RRR is the central bank’s primary instrument for regulating bank lending. Prior to 2015, the RRR had been unchanged for nearly three years, but this year it has been lowered twice for a total of 1.5 percentage points. The PBoC over the last six months has also twice lowered reference rates for loans and deposits. The PBoC also has lowered interest rates to banks on short-term (reverse repo) credits, with the result that short-term rates on the interbank market fell substantially in March. The PBoC has also granted banks short- and medium-term credit through other financing vehicles (SLF, MLF).

With the roles of various monetary instruments and their impacts unclear, China’s current monetary policy is hard to discern. The country is shifting, however, to interest-rate-based monetary policy. A prerequisite is the upcoming rollout of a deposit insurance scheme. The facts that banks will need to pay deposit insurance premiums and follow interest-rate-based monetary policy may also justify lower RRRs.

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