Posted by: Dirk | November 8, 2011

The role of reserve ratio requirements in China – a brake for credit growth?

I have recently presented some joint work with Finn Körner, showing Chinese data at a conference in Berlin. We had the impression that China is using the reserve ratio requirements (RRR) to fight inflation. Increasing the RRRs would lessen room for the banks to expand credits. This would only work if banks care about the RRR. In case they are not constraint by RRRs, changes in the RRR might only have psychological implications, which doesn’t mean that they wouldn’t work. Here is a graph from our presentation:

Since the Chinese authorities (government, PBoC) do not rely on the interest rate much, fighting inflation is different from a system where the central bank directly targets inflation. One very direct way of fighting inflation would be for government to spend less, but that of course is a political thing. Remember that in China you have many important state-owned enterprises that hunger for government funds.

So, the question of the day: Is China pushing on a string by changing the RRRs, or is there some subsequent change in lending behavior in the banking system? Some say, that the banks are getting subsidized through increases in the RRR, and that is all there is to it. The three following graphs might illuminate your way…

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