If the going gets tough for the Chinese economy, the plan is to loosen the reins on banks

Just open the doors.
Just open the doors.
Image: AP Photo/Alexander F. Yuan
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If China’s growth slows beneath the crucial 7.5% growth threshold that the government has promised, get ready for a torrent of new cash to gush into the financial system. Reuters and a state-run newspaper report that China’s central bank is prepared to cut the percentage of deposits that its banks are required to hold in reserve if economic growth is looking shaky—and that day could be soon.

The country’s reserve ratio requirement (RRRs) is currently 20%—which, as Quartz has reported, is super-high by international standards. Cutting that requirement would add billions to financial system, by allowing banks to loan out more money to businesses instead of parking it in their own accounts.

When China cut the central bank reserve ratio requirement, or RRR, by 50 basis points in February of 2012, analysts estimated it added some 350 to 400 billion yuan ($57 to $65 billion) to the financial system. The central bank followed that with another 50 basis point reserve ratio cut in May of 2012.

The central bank is considering cutting RRRs again, according to the Chinese paper Economic Information Daily, to “ensure steady growth and prevent potential risks,” a sign that policy makers are concerned about the health of the economy amid analyst concerns about it slowing and the risks of a “hard landing.”

Trimming the RRR could potentially help to shrink the shadow banking system, especially the high-yielding, high-risk investment products that have created a dangerous bubble of undisclosed debt in the Chinese banking sector. That’s because banks rely on shadow banking, using off-the-books securities called wealth management products, in order to skirt the reserve requirements. If allowed to lend more on the books, banks will, presumably, do so.

The overall impact of a lower RRR on China’s economy, though, is debatable. As researchers from Hohai University’s School of Business wrote in early 2012, after China raised the RRR 27 times between January of 2006 and March of 2011 to curb inflation:

China’s monetary policy regarding required reserves has not had a significant actual effect on dealing with excess liquidity, preventing inflation or controlling the increase of the loan scale.

Policy makers are presumably hoping that cutting the RRR will be more effective than hiking it was.