January 10,2011

No More Bank Lending Quota in China? A Dream Distant

By Lu Ting,Hong Kong

Will China scrap its bank lending quota and replace it with a "dynamic adjustment of differentiated reserve requirement ratio (RRR)"? This is the most frequently asked question of late after the People's Bank of China (PBoC) issued a statement on 6 Jan saying to use such a method to guide a stable loan growth. Interestingly, that statement didn't mention anything on loan quota as it did in 2010. Ms. Hu Xiaolian, the first deputy governor of the PBoC, said on 24 Dec 2010 that the PBoC will adjust RRR individually and frequently, based on each bank's systemic importance, level of prudence, financial ratios and past record of lending behavior. We believe scrapping bank lending quota is a distant dream in China. China still imposes lending quota, and the "dynamic adjustment of differentiated RRR" is used to allocate quota among individual banks.

No more lending quota in China? That's a distant dream

Some media hailed this move of the PBoC as on big market-oriented reform. Does the PBoC mean to make the big leap after heavy-handedly setting loan quotas for so many years? We are definitely less sanguine on this. In our view, it will take several more years (perhaps beyond the 12th Five-year Plan in 2011-15) for China to truly stop setting lending quota. Though Beijing may not explicitly announce a number, it will have to set the annual (or even monthly) loan quota for the banking system, and we think the core of "dynamic adjustment of differentiated RRR" is about how to allocate total lending quota among individual banks.

The rule of game changes at the micro level

In previous years, the rules of quota allocation were not clear, and the implicit rule was to allocate quota according to banks' existing sizes. But that was probably how 'bad boys' got rewarded. Each year for most of the past decade, bank lending quota has dried up quickly in the first several months as most banks play offensive in this zero-sum game of expanding their market share. Some overly aggressive banks did get punished by additional RRR hikes and forced purchase of central bank bills with below-market yields, but it seems that benefits always exceed costs. In our view, the new mechanism "dynamic adjustment of differentiated RRR" is used first to calculate lending quota for individual banks (given the total annual quota), and then is used to restrain (or punish) banks with more frequently adjusted RRR.

A realistic approach in the first year of 12th FYP

If setting the total lending quota is macro policy, the allocation of quota among banks could be defined as "macro-prudent policy", a fancy term increasingly popular after the global financial crisis. Though market-oriented reforms could eventually absolve the PBoC of setting loan quotas, the pace of such reforms could be very slow. In the beginning of this 12th Five-year Plan, quite a few fancy terms could be introduced, but it's our job to ascertain truth from illusions (the other example is basket-based currency regime, and a new fantasy is "interest rate linearization"). Actually, Beijing has already set broad money (M2) growth at 16% in 2011, meaning bank credit growth will be most likely around RMB7.0-7.5tn because credit and broad money growth are closely correlated.

(The author is a China economist with BoA/ML)
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