MNI: China's RRR Limits Tested By US Worries, Liquidity Needs

The People’s Bank of China needs to carefully weigh additional cuts to the reserve requirement ratio to ensure Chinese lenders have adequate buffers against any possible liquidity risk, sharpening regulators’ focus on banks’ liquidity management and investments, policy advisers and economists said.

The collapse of Silicon Valley Bank and the sale of Credit Suisse will have limited direct impact on China’s banking sector, with overseas branches suffering only small losses from exposure to Credit Suisse’s capital instruments and the volatility sparked by concerns about U.S. banking sector stability, plus they're backed by well-capitalised parent companies, said Lian Ping, head of the Zhixin Investment Research Institute.

Policymakers should use structural monetary tools and prudential regulations to help small and medium-sized banks improve liquidity management, said Dong Ximiao, chief researcher at Merchants Union Consumer Finance. He likened liquidity risk to a “heart attack” for financial institutions, underscoring the need for authorities to monitor investments made by systemically important banks and justifying the trend towards stricter liquidity regulation.

China’s banks are insulated against the turmoil in western banking systems, and their ample provisions held at the PBOC and restrictions on investment activities could hedge liquidity risk, said Liu Xiaochun, former president of Zheshang Bank. Besides an average 7.6% of deposits set aside, the PBOC assigns an additional 10%to 15% of deposits as provisions, which is a strong cushion, he said.

Liu added investment banking business of lenders was strictly controlled in China, having been brought on-balance sheet for regulation amid a wider crackdown on shadow banking and wealth management products. Only about 150 banks out of more than 4000 are still struggling to clean up shadow banking exposure, with most being city commercial banks that relied on interbank operations to expand.

Hong Kong authorities have demanded financial institutions report any Credit Suisse exposure, people working for HK lenders told MNI.

Chinese ratings agencies have also taken note of U.S. banking and economics headwinds. China Chengxin International Credit Rating Co placed the U.S government’s AAAg rating on review for a possible downgrade last week amid concerns about the impact of Fed rate hikes on banks and economic growth. “The debt ceiling issue and the recent banking crisis are eroding the credit base of the US dollar,” the company pointed out.

U.S. RECESSION

A bigger concern for China’s banks is the prospect of a U.S. recession, which would hurt exports and drag on the economic recovery, said JD Digits chief economist Shen Jianguang.

Lian said the PBOC would frontload easing measures, including another one or two RRR cuts, to ensure a strong recovery and liquidity support for credit expansion - such as long and medium-term corporate loans, property investment, mortgages - and to free up balance sheets of lenders to acquire government bond issuance. The PBOC may deliver stronger easing moves, including more RRR cuts, policy rate reductions and use of structural tools if western banking sector poses a systemic risk or slides into crisis.

Lian said the PBOC could continue cutting the RRR in small increments like 25bps to telegraph accommodative policy rather than a big easing. The accommodative signal sent by the PBOC via RRR cuts rather than the small scale of liquidity it unlocks will be more important in the future, the economist said.

SAFETY NET

The PBOC should keep a high RRR as a “safety net”, limiting the extent to which the RRR could be cut, Liu said. He said the RRR of 7.6% was not high compared to what he considered to be an appropriate level around 8%. (See MNI PBOC WATCH: More RRR Cuts Seen To Keep Liquidity Ample)

He added that while steering commercial banks to provide cheap funds for the real economy, regulators must also take into consideration lenders’ profits and the need to control liquidity and credit risks.

Zhang Ming, a senior fellow at Chinese Academy of Social Science, said the failure of SVB sent a warning to China's sovereign and private investors that the large-scale investments in US financial assets are risky, calling on Chinese investors to diversify their asset exposures at lower costs.