Chinas Banks Press PBOC to Cut Reserve-Requirement Ratio

By Lingling Wei
Wall Street Journal Markets
December 9th 2014

Niranjan Zende
GR522
11th December 2014

The article Chinas banks press PBOC to cut reserve-requirement ratio by Lingling Wei
does explicate some very important concepts that we have learnt in class during this semester.
The article emphasizes on why Chinese Banks are trying to get the Peoples Bank of China
(PBOC), the Chinese Central Bank to cut their reserve requirement ratio as the Chinese banks
profitability has come under increasing pressures. The article would help us understand the
effect of the monetary policy onthe aggregate demand and banking systemin the economy.

The reserve requirement ratio is a central bank regulation employed by most central banks
that sets the minimum fraction of customer deposits and notes that each commercial bank
must hold as a reserve (rather than lend out). It is one of the most vital tools in the monetary
policy. The PBOC uses changes in reserve requirements as an inflation-fighting tool.
Currently, the big banks in China have to hold an amount equivalent to 20% of the deposits at
the central banks. Historically, in order to boost credit, a reduction in reserve requirements
has been one of the main sources of cheap funding for the banks in the worlds No.2
economy.

As it can be observed from followingExhibit 1(a), a reduction in the requirement reserve ratio
would lead to an overall increase in the supply of money in the economy, as bank will lend
more money. The exhibit illustrates that an increase in the Quantity of Money Supplied will
make the Money Market Supply curve shift rightward from MS1to MS2which would in turn
lead to a decrease in the equilibrium interest rate from r1 to r2. The fall in the interest rate
would not only increase the flow of money but also stimulate investment in the economy; this
also shows the influence of the central bank over the interest rate in the economy by
controlling the quantity of money supplied.

Exhibit 1

The other implication of this fall in the interest rate in the economy which is evident in
Exhibit 1.(b)is the increase in aggregate demand represented by a rightward shift in the
aggregate-demand curve. This shift occurs due to an increase in the quantity of goods and
services demanded from Y1 to Y2 at the given price level P. This would very well explain:
how a change in the quantity supplied of money would lead to a change in the quantity of
output in an economy. The change in the level equilibrium interest rate influences many
crucial decisions in the whole economy especially decisions regarding savings and
investments. A rightward shift in the quantity of output would also be instrumental in
boosting the GDP of the Chinese Economy and also help reduce unemployment by creation
of jobs.

A cut in the reserve requirement ratio would by as little as 50 basis points would make
available 500 billion Yuan ($81 Billion) to Chinese banks to a boost in liquidity and increase
lending the economy. It can be observed from the Exhibit 2 from the article that the PBOC
has been holding back its reserve despite slowing growth in the GDP; in spite of the fact that

some Chinese economists think that the days of huge capital inflows are behind them. The
quarterly data clearly elucidates that the GDP of the Chinese economy has come to a stagnant
level and the Central bank must take measures either by decreasing its reserve requirement
ratio or by other Monetary policy tools; Open market operations by purchase of government
bonds or by lowering the discount rate(which would enable banks to borrow money at a
cheaper rate)also the central bank may try to relax the lending policies in order to reduce
liquidity problems and pressures on reserve requirements.

Exhibit 2

Although the PBOC has taken a few targeted measures for easing liquidity by providing
money via short term loans and lowering reserve requirements for small and regional banks
catering to farmers and small businesses. Thecrucial choice the Chinese government faces as
it grapples with slowing growth are either to open the credit plug while risking a surge of
debt or sticking to its policy of modest easing measures to ensure that the economy doesnt
bear a shock and jeopardize financial stability in the country.

12/10/2014

Chinas Banks Press PBOC to Cut Reserve-Requirement Ratio - WSJ

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12/10/2014

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12/10/2014

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Chinas Banks Press PBOC to Cut Reserve-Requirement Ratio - WSJ

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