The Chinese Central Bank Raises Bank Reserve Requirements Again In An Attempt At Curbing Runaway Economic Growth....

In the mundane world of central banking, one of the policy tools available to tighten credit is through the use of reserve requirements. Reserve requirements at Chinese banks were again raised yesterday, this time to 8.5% from 8.0% after a 0.5% rise last month.

As I explained in an earlier post, raising reserve requirements compels banks to deposit money into the central bank, interest free. So, every 100 Yuan deposited into the banking system generates the following potential Yuan available for lending through the banking system:

7.5%= 1,333.33
8.0%= 1,250.00
8.5%= 1,176.47

So you can see from the above illustration, that the Chinese central bank has tightened the availability of credit by nearly 12% since June. However, it is important to note that reserve requirements in China are still below those of some other Western Western nations like the US.

The biggest problem with raising reserve requirements and/or raising interest rates, is that it reduces the profitability of the banking system since they have to deposit more funds in the central bank interest free and tightening money also raises its costs. Higher cost money may force some borrowers to go bankrupt and increase loan losses in their portfolio.