Positive sentiment on Chinese banks ignores govt stranglehold

Added 21st May 2015

Positive sentiment on Chinese banks ignores govt stranglehold

When the People’s Bank of China imposed a 1% reduction on the required reserve ratio – the amount of cash reserves a bank must hold – on 20 April, bringing the rate down to 18.5%, it triggered a wave of positive sentiment.

However, Rothman, investment strategist at Matthews Asia, believes that the hopes of increased liquidity, a predicted spur in bank lending and subsequent boost in economic growth, are not accounting for the influence of the Chinese government.

“In China, the required reserve ratio for banks is primarily a tool to sterilise foreign exchange inflows,” he explained.

“In recent years there have been a lot of inflows into China, and the Chinese banking system has had the highest triple-Rs in the world to avoid inflation. However, more recently there have been more outflows than inflows, and they have reduced the reserve ratio in order to avoid unnecessary tightening. It is just a mechanical response.”

Rothman cited the hold that the government has over the banking system as the key factor in why China lowering triple-R will not live up to expectations of increased credit flows.

He expanded: “While the perspective of China having freed up ‘X’ amount of money to lend is true in theory, that is how it would work in a country with a real banking system where banks can do whatever they want.

“But in China every significant financial institution is controlled by the government. Lending is determined by demand and a loan quota set by the government. So if they cut triple-R but do not increase the loan quota there will not be more lending.

“It is a small positive for bank profitability but will have no impact on credit flows. While the government has been cutting required reserves but loan growth has been continuing to decelerate – they are not trying to increase credit flow, but slow down the growth rate along with GDP growth.”

Rothman went on to say that the Chinese interest rate cuts should also not be taken as growth stimulus, but a preventative measure to avoid fiscal tightening.

He said: “The government have cut interest rates three times over the last six months, but this is not stimulus – it is a mechanical response to the changing situation in the economy.”

“With the interest rate cuts there was a desire from the central bank to maintain the spread between the benchmark rate and inflation. Inflation has been coming down, so if they had not cut interest rates they would have effectively been tightening.

“The cuts were not designed to stimulate the economy, they were primarily designed to avoid tightening, and also to bring down financing costs for companies and local governments.”

However, Rothman added that, as with any change in economic policy, there will be a clear beneficiary – in this instance, small private companies.

“One of the government’s main objectives now is to bring down local financing costs, and the primary beneficiary of this will be small private companies,” he said.

“The majority of central bank new lending and loans outstanding are to the non-state sector i.e. private companies and households. This is an enormous change that hardly anybody has paid attention to, so when they bring down rates they are primarily benefitting private companies, who create a lot of the jobs and wealth.”

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