Targeted RRR reduction to promote inclusive finance

Executive Summary

Early evening on 30 September 2017, prior to the Chinese National Day, the People’s Bank of China (PBOC) announced to reduce the Reserve Requirement Ratio (RRR) targeted for the inclusive finance area starting from 2018. This move was made to further support the development of inclusive financial services, which has been regarded as part of the national strategy initiative. After big state-owned banks had established their inclusive finance divisions in the first half of 2017, the Chinese government has stepped up to encourage the financial services to support the real economy especially by boosting the lending activities to small firms. Most big and medium-sized banks will benefit from the liquidity release due to the reduction of their RRRs and banks' credit structures will be improved.

Inclusive finance has a wider meaning

Back in 2014, PBOC cut the RRR for financial institutions that targeted to extend loans to smaller and micro businesses and those relevant to three rural issues, namely agriculture, rural areas and farmers. Contrary to the previous moves, it has been the first time PBOC announced a targeted RRR cut for inclusive finance loans applicable to a much broader base of borrowers in the country, and quantitatively, is clearly defined with a credit ceiling. Inclusive finance loans must meet two criteria: 1) a single credit amount below RMB 5 million, and that 2) the loans are either operating loans to micro businesses, individually-owned business and farmers; guaranteed loans to start-up businesses; or student loans.

Hence, in addition to smaller businesses and rural financing, the move has also provided an update on what can be regarded as the inclusive financial services. The Chinese authorities intended to intensify the support for the development of smaller businesses, start-ups and innovative firms by lowering their lending costs, and more importantly, to guide the banks to divert their lending activities from shadow banking to inclusive financial services. (Please see Deloitte Research's August 2017 Monthly Outlook and Perspectives "Big banks benefit from curtailed shadow banking")

More liquidity for smaller businesses does not signal easing

The current official RRR for larger financial institutions, which are mostly banks, is 17% and that for medium-sized and small institutions is 15%. Under the latest measures, banks will be able to apply for the extra reduction from 2018 if their year-end inclusive finance loan performances of 2017 meet the following conditions.

Table 1: Two levels of requirements to apply for reduction on targeted RRR

Source: PBOC website, Deloitte Research

PBOC, based on its calculation, believes that the beneficiary banks will cover all big and medium-sized banks, 90% of city banks, and 95% of non-rural commercial banks. In view of this, researchers have estimated that around RMB 200-550 billion of liquidity would be released as a result of this new targeted RRR reduction. In fact, most banks have already met the first level of requirement for applying for a 0.5% reduction from the Chinese central bank's benchmark rate but a 1.5% reduction from the benchmark rate would be more difficult to attain and confined to those banks that lend out considerable inclusive finance loans.

With reference to publicly disclosed information, five big state-owned banks namely ICBC, ABC, BOC and BoCom (except for CCB) have applied for the 0.5% reduction from the benchmark rate. Taking into account the extended scope of inclusive finance, we estimate that all five big banks will be able to meet the required level for 0.5% reduction in 2018. Furthermore, following their newly-established inclusive divisions by June as required by the State Council and CBRC, some of these major banks are likely to meet the Level II requirement to apply for the 1.5% reduction during the next year, such as ABC with a higher proportion of business activities coming from the agricultural sector, and BoCom that possesses a higher proportion of smaller loans in its portfolio. In addition, some joint-equity banks such as CMBC, CMB, CIB and CITIC are expected to benefit from the 1.5% reduction from benchmark rate considering their respective diversified credit lending activities.

Another major deviation from the past reductions is that this new measure will be implemented after three months from announcement. We believe that PBOC would like to: 1) encourage banks to meet the applicable levels of requirement during the residual time of this year; 2) release the liquidity in a moderate pace. This move of cutting the targeted RRR is to curb the mounting pressure of higher financing costs in the inclusive finance area, due to the tightened liquidity caused by de-leveraging. Without any change from the key notes of a prudent and neutral monetary policy orchestrated by the authorities, it is unlikely to signal any easing and the targeted liquidity to be released will be limited.

Banks' credit structures will be improved

Given the recent favourable measures, banks are expected to adjust their lending appetite and proactively invest funds to the inclusive finance area so as to benefit from the targeted RRR reduction. The increased interest in inclusive finance would also lead to a decrease in shadow banking activities and divert off-balance sheet businesses back onto the balance sheets of the banks and this would improve the credit structures of banks.

As required by the State Council and CBRC, the big five state-owned banks established their inclusive finance divisions by June and they have moved on to prepare branching out this business to tier-one branches. It should be noted that joint-equity banks are not obliged to set up inclusive financial business arms, and, among them, only China Industrial Bank (CIB) pioneered to set up an inclusive finance division in October. We believe that its action might reflect its own innovative strategy for its long-term development. In this regard, we believe that more small and medium-sized banks may follow suit and expand to the inclusive finance business.

In conclusion, the move to targeted RRR reduction is part of the Chinese regulatory efforts to ensure strict financial supervision against shadow banking and ICOs and to guide the banks (mainly the big and medium-sized banks) to support the real economy through inclusive financial loans. 

Click here to read Comment on deleveraging China Newsletter Issue 1, 2017.