Why central bank downgrades the reserve ratio at this moment?

As I mentioned in last blog, Chinese central bank decided to cut the bank deposit reserve ratio over again by 0.5% since last November, implemented from Feb 24, 2012. After this adjustment, large financial institutions’ deposit reserve ratio will drop to 20.5% while the small ones will be as lower as 17%.

The reserve requirements are the amount of money and liquidity assets which banks must hold in cash or on deposit with the Federal Reserve System, usually a specified percentage of the demand deposits and time deposits. This is also the holding deposits saved in central bank to guarantee the customers withdrawing money, clearing and financial settlement. According to the central bank’s report last year, China’s RMB deposit balance was 80.9 trillion Yuan (8.09 trillion pounds), based on this, the money released by this cut was about 40.45 billion pounds.

Back to the title question, in my point of view, the reasons are as follows:

1) This is CB’s adjustment for fine-tuning and presetting monetary policy. As I have talked in last blog, because the macroeconomic indicator is not optimistic for months, many indices are quite low. In order to keep stable economic growth and economic environment, government should take this adjustment.

2) New loan scale in January was much lower than expected. This was mainly due to some small and medium-size banks have a tight liquidity and inadequate capital requirement situation. Decreasing the ratio can increase the liquidity of funds.

3) Aggressive easing of monetary and credit policy can prevent hard landing of real estate market. As the increasing liquidity will tend to release some money to the real estate market, this fills the cash flow gap and helps dampen price pressure.

In addition, Of the Central University of Finance and Economics Professor Tian Yong, Guo (2012) said, at present, Chinese macroeconomic dilemma of liquid expansion is induced by funds outstanding for foreign exchange reserves. In the context of foreign exchange reserves jumped and large amount of foreign capital flowed in, that would let the funds outstanding for foreign exchange enhance. If the RMB exchange rate levels remain unchanged, the rise will increase inflationary pressures. On the other hand, since the less optimistic situation in Europe, reduced trade surplus, the decline in foreign exchange, making the future market liquidity continues to tighten up the possibility of existence. Alternatively, it is the large holding foreign exchange hedged and the high growth rate of M2, wide currency that is the further development of RMB.

China Economy-----in Queer Street?

Recent statistics states a slowdown in China’s economy; the quarterly economic growth suffers a slight decrease from 10.4% in 2010 to 9.2% in 2011, due to China’s macro-control measures. Such decline may have negative impact on the external and domestic investment demand to some extent.

When addressed whether the slowdown in China’s economy may postpone the global economic recovery, Chinese vice-president Jinping, Xi responds this from “Irish Times” (February 18, 2012) during his visit to Ireland last week.

As he said

“Starting from this year, we have lowered the target of economic growth. This will help reduce the pressure in terms of price, energy, resources and the environment. It will also help us accelerate the shift in growth model and increase the quality and efficiency of economic development.”

From Mr XI’s statement, is this supposed that China intends intentionally interested in the slowdown of the economy growth??

I am quite confused. For example, in the investment-intensive,a leading indicater economic power consumption of the whole society decreases year-on-year by 7.5%; alternatively, Chinese society total financing slumps sharply, reduced by nearly 50%, the new lending and loan scale in January fell to its lowest level in five years. In another hand, the inflation rate increased significantly from 4.1% to 4.5% since last December.

In response to the reports in January, Chinese central bank on February 19th, 2012 decided to lower bank deposit reserve ratio by 0.5%, implemented from Feb 24, 2012. This claim is expected to release 400 billion Yuan (about 40 billion sterling) and aimed at enlarging the funds available to banks for lending, for instance, high leveraged investment banks can make more disposal lending when credit is easy and pull back faster in the crash.

This is the second time the central bank drops down the reserve ratio since last November but as far as I am concerned, cut interest rate or take fiscal stimulus will be more efficient, normally involving increased public spending and lower taxation which give a positive jolt to economic activity. The decline in the reserve ratio is unlikely to lead to lasting recovery unless accompanied by strong measures to further stabilize and strengthen the financial system, so a new downturn with a massive fiscal stimulus package should be taken. (E.g. China last adopted a big stimulus package during the Asian financial crisis, when it succeeded in holding annual GDP growth at almost 8 %.)

However, perhaps the debate of the fiscal policy has not come to an agreement and need more studies in Chinese government. In addition, yet the Chinese government transition is near, it looks like the government will still spill over a little bit on the economy and the most important thing at the moment is the realization of steady and smooth transition, nor the positive and aggressive measures.

The Vexation of $3.2 trillion - to the Chinese Foreign Exchange Reserves (FER)

As every coin has two sides, it is also applied in Chinese FER.

With the Eurozone debt crisis spread to other Eurozone countries violently, (e.g. from BBC news on Feb 13, 2012, Greek bailout crisis and street violence has become a main topic among the Euro, further austerity measures about a 130bn euro bailout package was support by EU leaders.) and the US has not driven out the dark clouds of the debt default risk, Chinese finance ministers look like ambivalent and complicated, which is a kind of agitated, helpless and anxious.

As I have analyzed the liquidity, adequacy and diversity for Chinese FER in last blog, now I will talk about the annoyance for this large amount capital.

As we all know, from the $3.2 trillion US bucks, the dollar assets take account of about 70% (among them 1.16 trillion is US bonds), Euro assets is estimated as much as 20%. In addition, With the Standard & Poor downgraded the US Credit Rating to AA-Plus on April 18, 2011, Chinese Government was seriously worried about the security and capital maintenance (hedging) of the store reserves as the US Government Bond is the main investment and transaction products.

Furthermore, China, the largest foreign-government creditor should claim against the US government to solve out the structural debt problems and the US Congress to safeguard the National debt investment security and market well- functioning. So that reducing the volatility to the international financial markets and realizing diversified sources of investment strategy within the FER.

In a short, my conclusion is that:

“The US kidnap the global economy, and Chinese Foreign Exchange Reserves is the hostage.”

Today, I was chatting with a friend about Chinese Foreign Exchange Reserves (FER), he asked “since China holds as much as 3.18 trillion US dollars FER, do you think it looks too fat and why not rescue the EU debt crisis with part of them? What does $3.18 trillion mean in real life?

 What I told him was as follows:

It cannot deny that the central bank of China has massive money, but it is some kind of a general lack of imagination. Quite a large part of the foreign exchange reserves are held in form of the US Government Bond. Whether China has a thought of “Buy Europe Out” or not, it is certain that China has sufficient appetite and capable to buy whatever he is willing to buy, though Chinese Premier J.B. Wen stated that it is such a ridiculous joke for china’s intention for a buyout of Europe when he met with German Chancellor Angela Merkel in Guangzhou on Feb.3.2012.

With such substantive foreign exchange reserves,

 1)      China can purchase the sum of the national debt among Spain, Ireland and Greece so that solve out the EU debt crisis shortly. And if China did it, it can still keep half of FER.

2)      China can send a Tata Nano( the cheapest car in the world) generously to every Indian( 1.27 billion Indians) and the remaining money can even buy one-year petrol, which is easily “accelerate” India and solve the paralyzed and congested traffic in India.

3)      Rather than purchase large amount of US Government Bond, China can buy corporate stocks as much as he likes. Suppose if China “swallow up” Apple, IBM, Microsoft and Google with merely no more than 1 trillion US dollars, how could it be in the Internet world? Monopoly?

4)      Like some Arab sheik and Russian oligarches, China can purchase the UK football clubs. According to Forbes, the gross value of world’s 50 most valuable Sports Organizations in 2010 was just 50.4 billion US dollars, less than 2% of China’s FER

5)      When take account of the real estate investment, China’s FER can totally purchase the whole Manhattan with a payment of $0.287 trillion and $0.232 trillion for Washington DC!! Since China is accustomed to be the creditor of Washington, why not change the role to the landlord?

6)       Finally, theoretically, China can also buy the US Department of Defense! According to the balance sheet acquired in 2010, the value of the organization is about 1.9 trillion which includes the plant, equipment and entities, while the gross value of the weapon is just $0.4137 trillion dollars.

The Brief Analysis On the Reason Why the Windfall Profits Appeared?

Since the first blog was talking about the windfall profit appeared in the Chinese bank industry, now I will concentrate on the reason why and how this abnormal profit produced.

As my first blog has mentioned that usurious interest margin, high transaction cost, frequently and overwhelmingly growth on financial products conduction has become the root of this windfall profit.

In detail, I will place the main emphasis on the first usurious interest margin. It says that the gap of saving and loan has become the big source of bank’s extravagant profit. For example, the one year time deposit interest rate in 2011 was 3.5%, while the loan rate for 1-3 year was as high as 6.65%. Under this policy, the banks can guarantee a difference of 3% between loan and saving rate, which is what the specialist called “sit-in money”.

In the first three quarters of 2011, the revenue earned from net interest rate margin in the 5 nationalized banks took up 75.7% of the gross, which the other equity banks account for the percent of more than 90%.

In terms of the gain on interest, most banks maintained their robust growth with a year-on-year rises of around 30%. In addition, on Feb.4, 2010, when talked about the reform of Chinese marketization of interest rates, the Vice Chairman of Financial and Economic Committee of People’s Congress, X.L. Wu, pointed out that, in order to carry out the reform steadily, we should leave them to market forces, optimize the allocation of financial resources, meanwhile, the central bank should regulate and control the upper limit of the saving rate and lower limit of the loan rate to supervise the interest rate premium on saving and loans, as the richness interest rate premium has become the important headstream to make the profit in the financial markets.

Harshly denounced on Chinese Banking System----Why always people foot the bill for its monopolized windfall profit ?

Recently, the Vice Secretary General of China Centre for International Economic Exchanges (CCIEE), Y.J. Chen stated that “the windfall profit in Chinese bank industry has outstripped the profit in industry of tobacco and petroleum”. Since then, a remark caused great controversy immediately in the society. The bank industry again has been harshly denounced by major people due to its extravagant profits and monopolized power. In addition, the summarized report of Bank Performance in 2011 indeed verified this “windfall profit” statement. Usurious interest margin, high transaction cost, frequently and overwhelmingly growth on financial products conducting has become the root of the phenomenon, to make things even worse, the major victims are the vast number of depositors, lenders and Chinese real economy, who foot this bill unwillingly.

The windfall profit and overtop salary makes banking the most popular industry. We can explain it with Performance Report in Banking Industry of 2011 as a reference, for example, the bans of “Shenzhen Development” in 2011 declared that the net profit assigned to the shareholders in quoted company is around 1 billion to 1.061 billion pounds, year on year growth rate was about 60% to 70%; the Shanghai Pudong Development Bank attained the net profit of shareholders assigned to the parent company is about 2.724 billion pounds, year on year growth rate was 42.02%; the China Industrial Bank has earned 2.515 billion pounds in 2011, year on year growth rate was 37.74%. Above all, the growing speeds of Listed Commercial Banks’ profit are all exceed the market expectation, respectively.

According to the statistical data of China Banking Regulatory Commission (CBRC), in the first three quarters of 2011, the accumulated net income of Chinese commercial banks was 81.73 billion pounds, year on year growth rate is 35.4%, quite near to the after-tax net income of the whole year of 2010, the average capital profit ratio is about 22.1%, the operating costs have increased by 20.85 billion pounds; profit per capita is around 40 thousand pounds. As rough estimation and prediction based on this results , the accumulated net income of Chinese commercial banks will increased to 100 billion pounds by the end of year 2011, so does the profit per capita will up to 50 thousand.

But compared to this, the net profit of large scale major industrial enterprises in the first three quarters are merely around 368 billion pounds, spread and distributed by 87 million people (workers), the profit per capital is just no more than 4,000 pounds.

Meanwhile, under the high net income, the high salary and year-end bonus in bank industry also leave others too far behind to catch up with. For example, in 2011, the regular staffs with up to 3 years’ working experience can get a year-end bonus for around 8000 pounds. Notably, the staffs employed in small and medium size equity banks always attain more than those in the large scale nationalized bank.

Furthermore, in the Various Sectors of Salary Ranking List, financial sector is still unbeatable. From the report, Minsheng Bank ranked the top with respect to the labor payoffs of first half year of 2011, which is as higher as 19.07 thousand pounds; come next is the China Merchants Bank, which is 17.89 thousand pounds. Among the 16 Listed Commercial Banks, there are 10 banks with employee payoff exceed 10 thousand pounds, the other 6 are consists of 5 major nationalized banks and Beijing Bank.