China's central bank's new cut in the reserve requirement ratio (RRR) for small and medium-sized banks will boost supply-side structural reform in the financial sector at a time when the economy is slowing down in its transition from high-speed growth to high-quality development, market experts said.

The RRR is the minimum fraction of customer deposits that commercial banks must retain as reserves instead of lending out. The new round of policy easing, the second this year, will create additional liquidity of nearly 280 billion yuan ($40.58 billion) for some small and medium-sized banks for lending to private enterprises as well as micro and small firms.

According to a statement by the People's Bank of China (PBC) on May 6, around 1,000 county-level rural commercial banks will benefit from this round of RRR reduction. The RRR has been cut to 8 percent, equal to the RRR for small rural credit cooperatives. Commercial banks with county branches will also enjoy the cut if their asset size is less than 10 billion yuan ($1.45 billion).

The RRR for small and medium-sized banks used to be between 10 and 11.5 percent.

The RRR adjustment, being conducted in three phases, started on May 15. June 17 and July 15 are the two other dates. The phasing is to ensure that the liquidity is released in a prudent and orderly manner and is being used to provide inclusive credit.

This round of RRR reduction, aiming to set up a policy framework, is "conducive to…optimizing the structure of financial supply as well as the allocation of credit funds via reform measures," the PBC said in the statement. This, it added, will encourage small and medium-sized banks to better support private enterprises as well as micro and small firms and boost the real economy.

Samples displayed at the showroom of a small pipeline manufacturer in Mengcun Hui Autonomous County, north China's Hebei Province, on May 22 (XINHUA)

Policy streamlining

The PBC said after this round of reduction, the RRR system, characterized by "three notches and two preferential treatments," will be streamlined.

The three notches are the three benchmark RRR levels set according to features such as the financial institution's systemic importance, type and service positioning. The first notch, at 13.5 percent, applies to large banks, reflecting the need to prevent systemic risks and maintain financial stability; the second notch, slightly lower than the first at 11.5 percent, is for medium-sized banks; and the third notch, currently standing at 8 percent, is the lowest RRR meant for banks operating in counties and rural credit cooperatives.

The two preferential treatments supplement the three-notch system. First, commercial banks whose annual outstanding or new loans in inclusive financing exceed the required percentage of the total are eligible for a 0.5-percentage-point or 1.5-percentage-point RRR cut.

Second, county-level banks whose new deposits used for local lending reach a required percentage or more can enjoy an RRR cut of 1 percentage point.

"The RRR framework… is aimed at striking a balance between preventing financial risks and serving the real economy, micro and small enterprises in particular, and will be helpful for structural optimization," the PBC said. "Improvement of this framework will further streamline the RRR policy system, which will be more practicable and offer more explicit guidance to financial institutions."

Favorable for market

In January, the PBC carried out the year's first round of RRR cut, injecting 1.5 trillion yuan ($217.39 billion) into the market. Compared with that, the second round is smaller but more targeted.

A report by CIB Research, a Shanghai-based banking research company, estimated that this round of RRR reduction is equivalent to around a 0.2-percentage-point RRR cut across the board.

The timing of the cut as well as the policy behind it is significant.

For instance, the Changshu Rural Commercial Bank (CRCB) headquartered in Changshu, east China's Jiangsu Province, runs 30 branches in the four provinces of Hubei, Jiangsu, Henan and Yunnan, which are eligible for the new RRR cut. So they will have more funds to support farmers, agriculture and rural areas as well as micro and small firms.

"Most of our branches' loans go to micro and small enterprises or support agriculture and rural areas. They are experienced in this regard, and this round of RRR reduction will enable them to better play the advantage in the rural credit market," Xu Huichun, CRCB Board Secretary, told 21st Century Business Herald.

A rural commercial bank staff member (left) visits a farmer to learn about his financial needs in Menyuan Hui Autonomous County, northwest China's Qinghai Province, on May 3, 2018 (XINHUA)

More targeted cuts

A research report by Dongguan Securities Co. said there may be further targeted RRR cuts in the future though across-the-board cuts are unlikely.

"If there are targeted RRR cuts in the future, they are very likely to be on the second and third notches, particularly the second notch," Ming Ming, chief analyst for fixed income at Beijing-based CITIC Securities Co., said.

Ming told 21st Century Business Herald that city commercial banks, consisting of mainly medium-sized lenders, lend mostly to micro and small enterprises. To better support these enterprises, the central bank could offer targeted RRR cuts for city commercial banks.

However, in that case the central bank may also set conditions for the cuts, according to Dong Ximiao, Associate Dean of the Chongyang Institute for Financial Studies at Renmin University of China in Beijing.

The conditions may include requiring all funds released by the RRR cuts to be used for supporting private enterprises as well as micro and small firms, Dong told 21st Century Business Herald.

A research report by ICBC International said from April 2018 to January 2019, RRR cuts had released 400 billion-800 billion yuan ($57.97 billion-$115.94 billion) of funds. The report said another targeted RRR reduction is possible in June or July.

However, while the increased liquidity will be a shot in the arm for private enterprises as well as micro and small firms, there is a potential risk. According to PBC Governor Yi Gang, while in 2018 the non-performing loan ratio of micro and small enterprises was 2.75 percent, it jumped to 6.2 percent in March this year. Against this background, rural commercial banks' risk control capability is a cause for concern for financial regulators.

Copyedited by Sudeshna Sarkar

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