Exclusive: China scraps punitive reserves for some banks

BEIJING Tue Mar 8, 2011 5:11am EST

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BEIJING (Reuters) - China has reversed punitive reserve requirements imposed on several banks after getting them to rein in their lending, two sources told Reuters on Tuesday, an indication of success in a crucial part of the government's campaign to control inflation.

The move in no way means that the central bank is loosening monetary policy, but rather suggests that it is increasingly confident of its ability to manage credit growth and, by extension, price pressures in the Chinese economy, analysts said.

The cancellation of the punitive reserve increases followed reports in official media that total new loans in February were less than 600 billion yuan, a surprisingly low number.

After struggling to control unruly lenders over the past two years, Beijing has started tweaking mandatory reserve levels -- the portion of deposits that they must lock up at the central bank -- on a regular basis as a way of keeping them in line.

Formally known as "dynamic differentiated required reserve ratios," the central bank used this new policy tool earlier this year to punish more than 40 smaller banks that had been particularly profligate, according to official media.

By rolling back at least some of these increases, the central bank is demonstrating a willingness to be flexible and react quickly to changing credit conditions.

"If the pace of lending is reasonable, and indicators like capital adequacy ratio are normal, then it is natural to lower RRR," one source told Reuters.

In restricting banks' capacity to lend with higher reserve requirements, Beijing has been aiming to slow the pace of money growth that has kept inflation running near its fastest in more than two years.

"This suggests that the central bank's intervention has been working," said Ting Lu, an economist with Bank of America-Merrill Lynch in Hong Kong. "The rules of the game have been observed quite well," he said.

MORE TIGHTENING AHEAD

China has increased reserve requirements across the board for all lenders twice this year. The dynamic increases were on top of these and the central bank had said that they could be reversed once banks fell back into line with official lending and capital guidelines.

In this case, the most important factor appears to have been unexpectedly low loan volumes in recent weeks.

Chinese banks extended less than 600 billion yuan ($91 billion) in new loans in February, official media reported last week. Economists polled by Reuters had forecast new loans of 650 billion yuan.

February would mark the second consecutive month that bank lending fell short of market expectations.

Economists still expect China to continue to raise overall reserve requirements, an essential tool for mopping up the excess cash in the economy stemming from its massive trade surplus.

Required reserves already stand at a record 19.5 percent for the country's biggest banks. Official media have said the next increase is likely to come this month, even though there are signs of growing strains.

Li Lihui, president of Bank of China, the country's fourth-largest commercial lender said on Saturday that there was limited room to further increase required reserves.

But Wu Xiaoling, a former deputy central bank governor, said China should continue to rely on required reserves in order to drain liquidity from the economy.

The sources, who were familiar with the details, did not say which banks had been granted a reversal of their punitive reserve requirements.

(Reporting by Reuters China; Editing by Tomasz Janowski)

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