China: Increasingly complex financial system is driving a change in monetary policy - NAB

Gerard Burg, Senior Economist at NAB, notes that since the middle of 2015, the seven-day Shanghai Interbank Offered Rate (Shibor) has been unusually stable – when compared with the extreme volatility in this market over the preceding five years.

Key Quotes

“This highlights a low profile shift in the management of China’s monetary policy that was necessary to control an increasingly complex, interconnected financial system.”

“The gradual process of financial deregulation contributed to growing competition between China’s banks, at a time that they were also facing greater pressure from non-bank financial institutions. In particular, Chinese banks started to face increased competition for deposits. Long used to low yielding bank deposits, Chinese consumers embraced new alternatives that offered higher returns – such as short term money market mutual funds and longer term trust and bond market investment products. This contributed to the introduction of Bank Wealth Management Products (WMPs) in the latter part of last decade.”

“WMPs have been directed to high yielding (and often riskier) investments – such as bonds or shadow banking products like trust loans – increasing the interconnections between banks and non-bank financial institutions.”

“The switch towards a more modern approach to managing China’s monetary policy is encouraging – as it provides greater funding stability for the country’s increasingly interconnected banks. That said, more needs to be done – particularly around communicating policy targets (the IMF recommend using the 7 day reverse repo rate) and regulation (particularly with non-bank financial institutions).”