China's new reserve calculation rules to smooth liquidity

The latest adjustment to the calculation of the reserve requirement ratio (RRR) for bank by China's central bank will help smooth liquidity and facilitate the offshore renminbi market, according to a research note.

The People's Bank of China announced Friday that as of July 15, the RRR calculation will be based on the average of their daily outstanding deposits, rather than the deposit level at the date of assessment.

Calculating the RRR on offshore renminbi deposits held onshore will also be based on the average of such deposit holdings in the previous quarter, not just the holdings at the quarter-end.

China International Capital Corp. (CICC) said Saturday in a note that the new refinement will help smooth liquidity, because RRR as a potential source of liquidity shock will be weakened.

The central bank started to monitor the average reserve holdings of banks last September, but still assessed the adequacy relative to their outstanding deposits at the assessment date. Liquidity shocks may come when commercial banks fight to meet the reserve requirement when the assessment date nears.

In the future, this assessment will be made against the average deposits, meaning that the volatility of deposits will not affect the required reserve level for banks, but the average will, the CICC said.

"The move suggests the central bank's cautious attitude toward liquidity management approaching the quarter-end," it said.

The move will also facilitate the functioning of the offshore renminbi market, the CICC said.

To contain regulatory arbitrage, the central bank imposed the RRR on offshore renminbi deposits held onshore from Jan. 25. At the end of the first quarter, offshore banks rushed to offload their offshore renminbi funds in order to reduce the reserves they would be required to hold in the second quarter.

This type of shock is less likely to occur again, when the average of offshore renminbi deposits starts to matter, according to the note. Endi