CHINA Insights

China Insights: PBoC redefines deposit to expand lending capacity of commercial banks aggressively Monday, December 29, 2014 Highlights: 

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The expansion of the definition of “general deposit” will lead to the fall of loan-to-deposit ratio (LDR), which in turn will unlock more lending capacity for commercial banks. It is positive for both the real economy and market sentiment. CBRC, rather than PBoC, is in charge of LDR calculation, as such, we need to wait for CBRC’s confirmation on the new LDR calculation before jumping to the quantitative conclusion. Scrapping the LDR is more difficult than changing the LDR from legal perspective, but we are approaching the point. We disagree the market talk that the impact of the expansion of deposit category is equivalent to a big reserve requirement ratio cut. The chance of imminent RRR cut is much smaller.

The PBoC released the Document 387 on Sunday to redefine the category of general deposit. There are two important highlights for the new Document. First, following deposits will be included in the category “general deposits” 1. 存款类金融机构吸收的证券及交易结算类存放(Deposits received by deposit-taking institutions for purpose of securities transactions or settlement) 2. 银行业非存款类存放 (The definition is not clear yet, but most likely will include part of interbank deposits) 3. SPV 存放 (deposits from special purpose vehicles, the definition of SPV is not clear yet) 4. 其他金融机构存放 (deposits from other financial institutions) 5. 境外金融机构存放 (deposits from offshore financial institutions)

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Second, the newly added deposit groups will be exempted from mandatory reserve requirement ratio temporarily. This will help neutralize the impact on the liquidity.

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Waiting for CBRC The expansion of the definition of “general deposit” will lead to the fall of loan-to-deposit ratio (LDR), which in turn will unlock more lending capacity for commercial banks. Nevertheless, we think it might be too early to quantify the impact as the calculation of LDR is supervised by China Banking Regulation Commission (CBRC) rather than the PBoC. As such, we should wait for CBRC’s confirmation on the new LDR calculation before jumping to the quantitative conclusion. It is not uncommon that there is the discrepancy between the “general deposit” defined by PBoC and the deposit used by CBRC to calculate the LDR. Meanwhile, there is the possibility that the interbank lending may also be included in the loan part of LDR calculation. As such, the fall of LDR may not be as much as some newspaper estimated. A positive move We think the new Document 387 serves two main purposes from central bank’s perspective. First, it will further free up banks from restrictions of LDR via lowering the LDR. This will give banks more room to lend to support the real economy. Second, it is also in line with China’s national strategy to lower the funding costs. China has announced the measurements of month-end deposit deviation to stabilize month-end deposit and interest rate fluctuation. The falling LDR is likely to act as additional deposit stabilization mechanism, which may help lower bank’s funding costs. LDR may be scrapped in the long run Since this year, a number of new regulations have been related to LDR. One may think why China does not scrap the LDR directly if LDR has been the constraints to Chinese economy amid the slowdown. Scrapping the LDR is more difficult than changing the LDR from legal perspective as LDR has been written into China’s Commercial Banking law in 1995. The abolishment of LDR will require the change of law, endorsed by the National People’s Congress. Nevertheless, there is that talk that China’s banking regulator may have already proposed the revision of the law and the LDR restriction may gradually fade away next year. In the long run, we believe China will eventually scrap the LDR regulation. RRR cut? There is the talk in the market that the impact of the expansion of deposit category is equivalent to a big reserve requirement ratio cut. We disagree. It is only equivalent to a big RRR cut when banks try to convert their general deposit to interbank deposit for the purpose of regulatory arbitrage to enjoy the temporary zero RRR for interbank deposit. We don’t see this happen in a sizable scale for three reasons. First, the zero RRR for certain newly added deposit is only temporary and it will be eventually increased. The uncertainty will keep banks away from regulatory arbitrage. Second, it also underestimates PBoC and CBRC’s capability to monitor the situation. All the current regulatory changes are leading to a more transparent system. This will also curb banks’ capability to take advantage of new rules. Third and most important, the cost of general

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deposit is much lower than interbank deposit. As such, we see little incentive for banks to pay higher funding costs for the sake of regulatory arbitrage. The fact the newly added deposit will be subject to zero RRR suggests that the chance of RRR cut is lower. Previously, we expect the central bank may be forced to cut RRR to offset the impact of LDR change. Looking forward, we still remain cautious that China’s central bank will cut RRR aggressively in 2015. We still hold the similar view that targeted easing measures are still most preferred measures for the moment. To conclude, we believe the Document 387 is positive for both economy and market sentiment as it will unlock commercial banks’ lending capacity. Nevertheless, we still need to wait for CBRC for the detailed change of LDR calculation.

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