Another Reserve Hike in China

08/30/2011 3:32 pm EST


Jim Jubak

Founder and Editor,

Beijing isn’t done with fighting inflation quite yet.

Yesterday, August 29, the People’s Bank of China raised the amount that banks have to set aside as reserves one more time.

China’s central bank has now increased its reserve-requirement ratio nine times since September 2010. That—plus five increases in the country’s benchmark interest rate—haven’t been enough, though, to stop inflation from hitting a three-year high of 6.5% in July.

The People’s Bank added something new to the recipe in this increase. Instead of raising reserve ratios—the percentage of assets that banks need to keep on reserve—the central bank broadened the asset base that banks will need to reserve against.

Banks will now have to reserve against the margin deposits—an estimated 4.4 trillion yuan ($689 billion) across China’s banks—that they receive when they make margin loans to customers.

By broadening the asset base, this increase will remove about three times as much from the financial system as one of the bank’s regular increases in reserve ratios. Those erase about $50 billion, by requiring banks to keep more money locked up in reserve in the vaults of the central bank.

So logically, this move, Bank of America estimates, will remove about 900 billion yuan ($140 billion) from the financial system.

Starting September 5, China’s six largest banks will have to set aside reserves equal to 21.5% of their assets, using the expanded definition of assets. Smaller banks will have to set aside 19.5% of their assets starting September 15.

By adding margin deposits to the asset base that banks have to reserve against, the People’s Bank may also be hoping that—since margin loans will now be somewhat less profitable—banks will have an added incentive to reduce margin lending that goes now to finance stock and real-estate purchases.

That would have the effect—although probably a small one—of taking some of the air out of potential asset bubbles in those investment classes.

This latest move by the central bank will cut bank profits by an average of 1.36 percentage points, according to calculations by Shenyin & Wanguo Securities.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio here.

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