FX deposits at China’s banks
Have contracted by $250 billion
Last month the People’s Bank of China raised the level of required reserves on foreign-currency deposits at the country’s banks. I have been puzzling over it ever since.
In fact it is only recently that the PBOC has made active use of the FX deposit reserve requirement. This graph shows the history of the rate, based on the evidence I have been able to find:
So the FX reserve requirement appears to be a new monetary policy tool. We can understand its effect by looking at Chinese banks’ foreign-currency credit books. This graph show FX-denominated credit funds, expressed as sources of funds and uses of funds. (It is a stock measure, like a balance sheet, not a flow measure, despite the terminology.) It is likely that both borrowing and lending are mostly in dollars, though the currency composition is not reported in the publicly available data.
How does the reserve requirement relate to banks’ FX credit operations? To my mind, the most straightforward understanding of the facts is as follows. Starting in the second half of 2020, Chinese banks rapidly expanded their FX books. Indeed, banks’ FX deposits expanded more than at any other time in the data. To slow this increase, the PBOC hiked the reserve requirement twice in 2021, from 5 to 9 percent in total.
Beginning in 2022, China’s banks FX deposits began to contract. Perhaps this was a result of the tightening reserve requirement, which would have made it more costly for banks to issue those deposits. Another likely factor was the increase in US interest rates at this point, which may have led some depositors to move their funds elsewhere, in search of better rates. To slow this decrease, the PBOC has lowered the reserve requirement three times so far, in May and September 2022 and in September 2023. But as the graph shows, banks’ FX books are still contracting, by about $250 billion so far.
In other words, it seems that China’s banks have a large offshore dollar business, both economically and financially significant. The fluctuations in those credit operations respond both to policy moves and to international financial conditions. The next step is to fit this analysis in with the shifts in China’s exchange-rate policy regime, in 2011 and in 2017. More to come.