Figure 2 Excess Reserve Ratio in Chinese Financial Institutions



Declines in excess reserves were a key structural factor that led to the moderate fall in the aggregatemonetary base since the beginning of 2017. It is important to note that the excess reserve ratio is an indicator of liquidity in the banking system that is equally important as the size of the excess reserves. The excess reserve ratio for financial institutions in China has been on a downward trend in recent years. It peaked above 7 percent in 2001 before moving down to an average of about 3.5 percent between 2003 and 2008 and then falling further to the present level of 1.5 percent. This downward trend has been driven by a number of factors. First, the modernized payment system has significantly shortened the time required for clearing, largely removed frictions in the flow of funds, and lowered the time and transaction costs for transferring funds from other assets to excess reserves. Second, as an easier financing option the rapid financial market development has enabled banks to borrow from the market at any time needed to cover liquidity shortages, thus reducing the banks’ precautionary liquidity needs. Third, liquidity management has been improved and become more granular, allowing banks to have a more accurate understanding of the factors that affect liquidity movements and to reduce the impact of uncertain shocks. Some banks have developed advanced liquidity management systems that allow them to monitor the flows of real-time funds among their branches, thus making it possible to achieve higher efficiency of funds utilization by keeping their excess reserve ratios at a level close to zero, or even temporarily below zero at certain pointsin time, under the mechanism that allows themto overdraw the required reserves.

 

The need to hold excess reserves has also been weakened by the stronger institutional flexibility that is a result of the central bank’s recent continuous efforts to improve the framework for monetary policy operations. For example, the twin-average assessment approach has given banks more flexibility to manage liquidity during the assessment period. Introduction of the Standing Lending Facility and the Automatic Pledge Financing Facility has offered banks the option to request liquidity support from the central bank against eligible collaterals. More frequent open market operations—from twice a week to daily—provide an institutional guarantee for the central bank to timely address liquidity shocks from various sources and to send policy signals to manage and stabilize market expectations. All these developments have weakened the need to hold excess reserves for precautionary purposes. Obviously, this trend does not signal a tightening of liquidity in the banking system or changes in the monetary policy stance. Moreover, excess reserve ratios in Chinese financial institutions are subject to notable seasonal fluctuations at the end of each quarter and between different quarters, with the ratios moving up at end-June and at end-December due to regulatory assessments, extensive disbursements of fiscal funds, changes in deposits, or the banks’ own accounting operations, before they fall back again when the impact of these seasonal factors disappear. This is why simple comparisons of excess reserves ratios at different points of time are ill-advised.

 

 

II. Stable Growth of RMB Deposits in Financial Institutions

 

At end-June, outstanding deposits of domestic and foreign currencies in all financial institutions posted RMB 165.0 trillion, up 9.6 percent year on year and representing a deceleration of 1.1 percentage points from end-March. This was an increase of RMB 9.5 trillion from the beginning of the year, which was RMB 1.3trillion less than the increase during the same period of the last year. Outstanding RMB deposits registered RMB 159.7 trillion, up 9.2 percent year on year and representing a deceleration of 1.1 percentage points from end-March. This marked an increase of RMB 9.1 trillion from the beginning of the year, or a year-on-year deceleration of RMB 1.5 trillion. Outstanding deposits in foreign currencies registered USD 793.1 billion, which was an increase of USD 80.1 billion from the beginning of the year, representing a year-on-year acceleration of USD 51.3 billion.

 

In terms of the maturities of RMB deposits, demand deposits constituted a smaller share. During the first half of 2017, demand deposits accounted for 32.1 percent of the new deposits by the household sector and the non-financial corporate sector, down12.1 percentage points from the same period of the last year. This decrease was partly due to fewer issuances of local government and corporate bonds, a slowdown in real estate sales, and a strong base effect. Broken down by sector, deposits by households and non-banking financial institutions registered an acceleration of RMB 395.1 billion and RMB 605.2 billion respectively year on year, whereas non-financial corporate deposits recorded a deceleration of RMB 2.1 trillion year on year.

 


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