Time for PBOC to switch to policy rate system, Yam says

Yam says the existing reserve ratio mechanism is not efficient enough in managing money supply

PUBLISHED : Monday, 17 February, 2014, 5:38pm
UPDATED : Tuesday, 18 February, 2014, 2:18am

Beijing should adopt a Western-style interest rate policy mechanism to make capital allocation in the banking system more efficient, said Joseph Yam Chi-kwong, the former chief of the Hong Kong Monetary Authority.

Yam, who headed the city's de facto central bank from 1993 to 2011, wrote in a new research paper that making the change could help Beijing better manage liquidity in the financial system.

"It is time that China's central bank adopts a clearer system to manage money supply," Yam, now a professor at the Chinese University of Hong Kong, said in a media briefing yesterday.

Mainland authorities have historically conducted monetary policy mainly through the use of the required reserve ratio, which effectively rations the availability of credit in the system by setting the proportion of deposits banks must maintain as reserves. The higher the ratio, the fewer loans a bank can make. The mainland's reserve ratio currently stands at 20 per cent for the biggest banks.

But over the past 18 months, the People's Bank of China, which is actively pursuing a policy of liberalisation to let market forces play a greater role in setting the price of credit, has been letting the Shanghai interbank offered rate act as the key indicator of the availability of credit in the system.

"The introduction of a policy rate can send a clearer message from the PBOC on monetary policy and reduce the volatility of Shibor," Yam said.

If Shibor moves too dramatically in one direction, the central bank is in theory able to adjust money supply through the issue or repurchase of government bonds to nudge market rates towards the level that policymakers believe to be appropriate for the prevailing economic outlook.

The United States Federal Reserve, for example, conducts so-called open-market operations to adjust the supply of reserve balances maintained by banks to keep market interest rates roughly in line with the target it sets at its policy meetings.

The PBOC has been under steady criticism since the middle of last year for failing to provide banks with clear enough signals of its intentions regarding money supply and its concerns about the availability of credit.

A jump in Shibor in June last year, followed by similarly sudden surges in interbank rates in successive quarters since, has been blamed on the central bank's failure to communicate its policy intentions clearly.

The PBOC said the surges were a consequence of its actions to curb rampant lending outside the formal banking system.

Yam said the emergence of the huge shadow banking sector was evidence that the mainland's existing banking system was not functioning well.