Chinese banks strengthen reserve ratios

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China reserve requirement ratios now 5.5 percent higher than U.S. norm

By Chris Devonshire-Ellis

BEIJING, Mar. 21 – The Chinese government has announced its 15th increase since mid 2006 of the minimum reserve ratio deposit lenders must hold in reserve, to a record high of 15.5 percent. This compares to the United States, reeling from sub-prime debt, where the system is based upon a sliding scale depending upon available reserves and the size and type of lending, of just 10 percent.

The move may have short term fall out repercussions in China. Banks that are under-funded will fall more under the control of the People’s Bank of China, and some smaller provincial lenders may indeed be allowed to collapse into absorption, depending upon the lenders and the nature of the debt. China, mindful of social unrest issues, is more likely to bail out errant lenders unable to maintain sufficient liquidity, although it will be at the price of giving Beijing more control.

It means that Beijing has achieved three objectives; one, being able to reign in the more previously aggressive provincial and local city banks, and collectively seek to dismantle bad debt on their books and manage this from a local welfare perspective, two, in bringing in a measure to control inflation through better control of it’s lending facilities, and third, although not acknowledged, via the re-packaging of debt to domestic and Hong Kong based reinsures ready to take a punt on the growing ability to recover debt from the developing commercial and middle class of China’s major cities.

The shift is equivalent to 50 basis points, at a time when United States is expected to cut rates by 100 basic points – further contracting Chinese interest rate policy.

The forecasters are expecting even higher measures. Macquarie Bank has indicated it expects China’s reserve ratio to be revalued upwards every two months, while Lehman Brothers forecast a rise of 300 points this year. Whichever the case, it is apparent that U.S. liquidity, in flight from a potential recession, is finding a happy home in China, and that this money is set to bail out China’s previously appalling bad debt ratios within its banking sector.

Even this though may not be enough post 2009. The funding of China’s many unproductive SOEs in lieu of a balanced and manageable insurance based welfare system still has a long way to go, and China cannot rely on the windfall from a US downturn and weakness of the dollar indefinitely to mask its own inherent domestic debt problems. The road ahead: Rocky.