China Cuts Reserve Ratio, Unlocks 700BN Yuan Amid Rising Trade War, Mass Defaults And Margin Calls

As widely expected, China's central bank announced it would cut the Required Reserve Ratio (RRR) for some banks by 0.5% effective July 5, just over two months after the PBOC did a similar cut on April 17, the first such easing since the start of 2016.

The move is expected to unlock 700 billion yuan ($108 billion) in liquidity amid growing trade war tensions, a sharp slowdown in the Chinese economy, a tumbling stock market, rising forced margin call, and a spike in corporate defaults.

According to the central bank, the aim of the cut is" to support small and micro enterprises, and to further promote the debt-to-equity swap program." The cut will apply to major state-run commercial banks, joint-stock commercial lenders, postal banks, city commercial lenders, rural banks and foreign banks, in other words: virtually everyone.

“The size of the liquidity being unleashed has beat expectations and it’s larger than the previous two cuts this year”, said Citic fixed income research head Ming Ming. “It’s almost a universal cut as it covers almost all lenders.”

The RRR cut was also widely expected following the publication of a central bank working paper on Tuesday calling for such a cut.

According to Bloomberg, the cut is designed to achieve two things:

  • The 500 billion yuan unlocked for the nation’s five biggest state-run banks and 12 joint-stock commercial lenders will be channeled to debt-to-equity swaps, which can reduce companies’ debt burdens and help cleaning up banks’ balance sheets. It comes following no less than 20 corporate bond defaults in 2018, and ahead of a wave of corporate repayments that has prompted analysts to express fears about a default avalanche. Chinese companies have to repay a total of 2.7 trillion yuan of bonds in the onshore and offshore market in the second half of this year, and together with another 3.3 trillion yuan of trust products set to mature in the second half. The pressure on China's corporate has manifested itself in the spike in the yield premium of three-year AA- rated bonds over similar-maturity AAA notes, which has blown out 72 bps since March to 225 basis points, the highest level since August 2016, an indication of the recent pressures on weaker firms.

  • Separately, the 200 billion yuan freed for smaller lenders such as the postal bank and city commercial lenders will be used to support funding for smaller businesses. It comes amid concerns that the growing trade war between the US and China could further impair the already sharply slowing down Chinese economy which earlier this month reported "shockingly weak" economic data...

... amid a plunge in China credit creation and a record drop in Chinese off-balance sheet financing, and is meant to provide an economic spark to offset the risk of further economic contraction.

In a separate statement, the PBOC said that the move will "help push forward the steady progress of structural deleveraging, and strengthen support to the weak links of small-and-micro businesses. It is a targeted and precise fine-tuning. The PBOC will keep implementing prudent and neutral monetary policy, and create a favorable monetary and financial environment for high-quality development and supply-side reform."

However, countering speculation that the RRR cut may indicate a shift in China's deleveraging posture, Wen Bin, a researcher at China Minsheng Banking Corp. told Bloomberg that "the RRR cut this time doesn’t change the PBOC’s prudent policy stance. The decision fits the current economic and liquidity situation. It is also an innovative move and addresses structural problems, as the central bank ordered the lenders to use the money unleashed to push forward debt-to-equity swaps and support small-and-micro-sized businesses. This can help relieve financial burdens for some companies while reducing leverage."

In other words, China is spinning the RRR as a move meant to fund mass deleveraging through debt for equity swaps, not as the start of an easing cycle which would send the Yuan sliding and could potentially be perceived as a stealth devaluation by the US, resulting in even more aggressive trade retaliation.

The move will ease liquidity shortages currently seen in the implementation of debt-to-equity programs, and it shows that policy makers still don’t want to send a signal of across-the-board easing, Ming said. "The central bank may have predicted rising debt risks in the near future, so it decided to set up such an arrangement," he said.

That said, the PBOC explicitly said that the funds unlocked from the reserve ratio cut shouldn’t be used to support so-called zombie companies, of which China has many as even the IMF noted in December. It remains to be seen if this is just a smokescreen, considering that the companies most in need of deleveraging are precisely China's "walking dead" companies.

Finally, there is the market, which many have suggested is the real reason for the much anticipated cut. As a reminder, the Shanghai Composite recently slumped below 3,000 for the first time since the summer of 2016.

The risk here, however, is not just to China's wealth effect, but to a wave of margin calls resulting in forced selling of stocks pledged as collateral for loans. About $1 trillion worth of stocks listed in Shanghai or Shenzhen, China’s two main market, are being pledged as collateral for loans, according to data from the China Securities Depository and Clearing Corp., or ChinaClear. The staggering number is equivalent to about 12% of the market.

Plenty of Chinese stocks are also used as collateral in margin financing, whereby investors borrow to plow more money into stocks. In all, some 23% of all market positions were leveraged in some way by the end of last year in China, according to Bank of America Merrill Lynch.

As the WSJ explained recently, the pledging of shares as loan collateral is particularly prevalent among smaller private companies. Unlike in the U.S., where institutional shareholders are a big market presence, private Chinese firms are often controlled by a major shareholders, who often own more than half of company. These big stakes are the most convenient tool for such big shareholders to raise their own funds.

Here the risk for other shareholders is that when major investors take out such share-backed loans is that stocks can plunge sharply when the borrowers run into trouble. Hong Kong-listed China Huishan Dairy fell 85% in one day in March 2017: It is unclear what triggered the selloff in the first place, but the fact that Huishan’s chairman had pledged almost all of his majority shareholding in the company to creditors likely made the crash worse.

And, as a result of the recent market rout, last week UBS said that it sees a growing risk in China's stock pledges; the bank calculated that the market cap of pledged stocks that have fallen below levels triggering liquidation amounts to 440 billion yuan with some 500 billion yuan below warning line, which translates to ~1% and 1.1% of China’s entire market value of $6.8 trillion. A separate analysis by TF Securities, as of Jun 19th, stock prices of 619 companies were close to levels where margin calls will be triggered.

It is unclear whether the relatively modest $100BN in released liquidity will be able to hit all of China's desired targets of assisting corporate deleveraging, slowing the mass default wave, preventing the economic slowdown and arresting the stock market rout and surging margin calls. It is, however, unlikely especially if Trump persists in imposing further tariffs on Chinese goods, suggesting that as much as the PBOC denies it, today's RRR cut is just the start of China's easing process.


Jus7tme Giant Meteor Sun, 06/24/2018 - 11:09 Permalink

What about capital ratios? The conventional wisdom these days is that capital ratios are the limiting factor rather than reserve ratios, at least for US and Europe. Although ECB has a 1% RRR, it may not be the limiting factor for EU banks. Here is a link about capital ratios or ECB memmber banks…

Perhaps @hedgeless_horseman would care to comment?

(At the moment I write this my comment is right above the hedgeless_horseman 1% comment....)

In reply to by Giant Meteor

shortonoil Giant Meteor Sun, 06/24/2018 - 12:04 Permalink

The Chinese economy is like the US shale industry; massive over production capacity based on the sky high leverage of none performing debt. Both require enormous, and growing amounts of energy to maintain. China's problem is that its oil fields are puking, and its coal industry has been reduced to mining combustible mud! The Western banking system can only continue to exist as long as it can feed on the emerging market's capital structure. China is the biggest pig on the lot, but it is one that will not be easy to take down. Trump had better remember that this sow is much bigger, and smarter than the one that was in Venezuela.

In reply to by Giant Meteor

peopledontwanttruth bike Sun, 06/24/2018 - 20:11 Permalink

a little chaos is good for everyone

Before I jump on your “order out of chaos” mentality.  I’d like to ask the survivors in the Middle East and parts of Africa and Venezuela to hondorus to Korea and Vietnam just to name a few how they feel about the chaos that has been leashed/good for them and their families above and below the ground.  

We haven’t seen chaos in this country “YET”.   

When it hits I’d like to get your take on it then 

In reply to by bike

hedgeless_horseman Giant Meteor Sun, 06/24/2018 - 09:56 Permalink


ECB Reserve Ratio Requirement is 1%.

Full speed ahead and no room left to maneuver. 

When Europe hits the iceberg, 99% of depositors are going for a cold swim.

The good Capt. Draghi will say something like, "Nobody could have known that there are icebergs that big."

For years afterward, the 1% will talk about how frightening it was for them in the lifeboats, hearing the horrible wails of the drowning 99%.


In reply to by Giant Meteor

rex-lacrymarum hedgeless_horseman Mon, 06/25/2018 - 12:12 Permalink

I don't disagree that large parts of the euro-land banking landscape continue to look rickety, but your statement about the required reserve ratio is utterly meaningless in isolation. No conclusions whatsoever can be drawn based on this. 

First of all, actual reserves are somewhere between 20% to 25%, not 1% - and for the time being, they continue to grow. This is an unavoidable side effect of QE, as the banks amass ever larger excess reserves - and since these grow much faster than the expansion of inflationary bank credit in Europe, their proportion to extant demand deposit money continues to grow every week. Moreover, euro-land banks on average now sport tier-1 capital of close to 15-16% of risk-weighted assets, again way above the 1% minimum reserve ratio for demand deposits. 

If you want to make arguments about European banks, they will have to go into a lot more detail. The minimum reserve ratio is simply not providing any useful information at this juncture. It's purely symbolic - when the ECB cut it from 2% to 1% many years ago, the actual bank reserve ratio stood at 5.8% - and it has never been lower since that day. 

In reply to by hedgeless_horseman

jmack Sun, 06/24/2018 - 09:48 Permalink

This may be it.  China is trying to take a baby step, ,to reassure the market, to build confidence, that they will step in if things go south.  But things are going south and they are not stepping in totally, they are only taking a baby step.  So if confidence is shaken instead of reassured, this could actually precipitate a rush for the exits that will snowball into a full fledged crash as margin calls are hit, both in margin accounts and pledged stock.    

schrock jmack Sun, 06/24/2018 - 10:36 Permalink

Doesn't look like a baby step to me.…
“The size of the liquidity being unleashed has beat expectations and it’s larger than the previous two cuts this year”, said Ming Ming, head of fixed-income research at Citic Securities Co. in Beijing. “It’s almost a universal cut as it covers almost all lenders.”

In reply to by jmack

jmack schrock Sun, 06/24/2018 - 11:57 Permalink

The change will also help ease a funding squeeze for lenders, which have to repay money borrowed from the central bank’s medium-term lending facility, and put aside cash for both the July tax season and upcoming quarterly regulatory checks.

if the shibor stays flat or remains trending up, I would say the measure is a failure and cash hoarding/liquidity tightness is still in effect, and further measures will have to be attempted.

In reply to by schrock

Giant Meteor earleflorida Sun, 06/24/2018 - 10:32 Permalink

I agree Earle. Before that happened, China would kill China. Just enough say, to cause greater pain for the great many whom rely on the China miracle for their daily bread.

China plays the long game, as they always have, and I believe would have no problem putting down any internal revolts, rebellions that may arise, and certainly must have been preparing for the contingency, right from the beginning ..

Of course the other consideration is, everything is miraculously fixed and everybody lived happily ever after ..

In reply to by earleflorida

earleflorida Giant Meteor Sun, 06/24/2018 - 10:49 Permalink

the sad part is it will play out in America with moar pain

China's CB is not the same as the private USSA FRB (CB) System which btw collects taxes from all individual Americans [used] to pay down the GND interest debt of this foreign owned and operated 'Loan Shark` Enterprise Ponsi Scheme!

debt. China ain't got that problem so the interest or taxes go directly paying their [own]

In reply to by Giant Meteor

philosophers bone Sun, 06/24/2018 - 10:10 Permalink

"Debt to Equity Swap Program" - code for your debt is so far underwater that you might as well go all the way to the back of the line.

"Swap" makes it sound like it's a fair exchange of consideration and "Program" makes it sound like it's something standard and official.

When do we get our debt (deposit) to Equity (new bank stock with worthless assets) in the West?


jmack philosophers bone Sun, 06/24/2018 - 12:01 Permalink

dont worry.


The funds unlocked from the reserve ratio cut shouldn’t be used to support so-called zombie companies, the PBOC said.

if the company is connected enough to be a zombie company, they are connected enough to benefit from the RRR cut, thus sucking that air out of the room for growing concerns.  That is why a fake/fixed market is so dangerous, there can be no true creative destruction.

In reply to by philosophers bone

truthalwayswinsout Sun, 06/24/2018 - 11:20 Permalink

China has over 29800 Bernie Madoff Bombs ready to go off. 200 have gone off since January with just one of them costing $200 billion of the US Treasury Bonds that China had to sell to avoid total liquidation and collapse of the economy.

The idiots who run China have just one choice, keep the status quo or they are out of power faster than the Communists were thrown out of Russia.

They need to bluff the US into caving on trade and they have a fair chance of doing so because they can always bribe the US politicians and or their families to see if they can keep the money train going.

But with the Senate killing ZTE you can get a quick feel for how fast China will fall apart with a boycott. Of course Apple, Amazon, and Walmart will have a lot of trouble but the reality is who cares about the China slave labor lovers.

Trump needs to inform all the US companies that are Chinese unfair trade lovers that on XX date there will be a full boycott and make them keep it a secret. That will allow the companies to use the massive tax rebates they got to build automated factories in the US. Of course wonderful Apple used $108 Billion of that tax rebate for share buybacks and dividends. Not a hint of any automated factories being built in the US. What is really funny about slave labor is the Communists hate gays and Apple is gay central as far as management is concerned but they really don't care so long as they keep the money train rolling.