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Chinese Central Bank’s New Liquidity Tools Improve Monetary Management: Moody’s

Summary

Moody's says the People's Bank of China's use of longer tenor liquidity tools is improving its ability to adjust liquidity without disrupting the market.

PBOC has made increasing use of medium-term lending facilities and pledged supplementary lending since the start of 2017.

Use of the facilities is also spurring bank compliance with China's macro prudential assessment system, which lies at the core of its monetary policy framework.

The People’s Bank of China’s use of new monetary policy tools characterised by longer maturities has heightened its ability to adjust liquidity without hampering the economy, according to Moody’s Investors Service.

Moody’s analysts say the use of the medium-term lending facility (MLF) and pledged supplementary lending (PSL) by the Chinese central bank enables it to maintain the broader direction of monetary policy while preserving market stability.

“Given their longer tenors, the medium-term lending facility and pledged supplementary lending allow the BOC, as the country’s central bank, to communicate a longer term view on its liquidity provision, which increases predictability for market participants, including the banks,” said Moody’s Assistant Vice President and Analyst Yulia Wan.

“The development is in line with a visible decline in interbank repo rate volatility since mid-2017, when the central bank made a clear shift to the one-year MLF from three or six months.”

PBOC first launched the two facilities in 2014 as a complement to its shorter-term liquidity instruments, which include repos and reverse repos, the standing lending facility (SLF) and short-term liquidity operations (SLO’s)

Since the start of 2017 PBOC has made increasing use of MLF and PSL to expand its balance sheet, with the two facilities accounting for 72% of PBOC’s claims on other depository institutions as of the end of October, as compared to 65% at the end of 2016.

According to Moody’s the use of longer tenor facilities brings two chief benefits to Chinese monetary policy and the banking system.

The first is that they improve the funding structures of commercial banks because of their enhanced stability compared to repos and interbank borrowing.

The second is that they reduce capital costs because of the lower interest rates on MLF funding compared to market alternatives for the same maturities, providing banks with a profit boost.

The one year MLF is also a better match for the maturities of bank liabilities.

Moody’s further points out that the new tools are helping to drive compliance with the Macro Prudential Assessment system that lies at the core of China’s monetary policy, because banks must satisfy MPA requirements to qualify for MLF funding.

This is especially the case for smaller Chinese lenders that are more dependent upon non-deposit funds, such as interbank borrowing.