Although risks to financial stability in China remain firmly to the downside, authorities are taking steps to strengthen the local financial system. Under new regulations, banks will be required to hold liquid assets equivalent to 60% of net cash outflows from 1 March, before that ratio rises to 100% by 2018.
The People's Bank of China is trying to rein in lending and resist interfering in the interbank market in the hope that banks better manage their short-term liquidity positions. However, liquidity shortfalls and the risk of rising bad debts among a few banks threatened the overall stability of the financial system on three occasions over the past year. This caused the PBoC to pump in extra cash to lower rates and restore confidence and has prompted policymakers to introduce new regulations.
The concern is that relaxed underwriting standards during the policy-induced credit binge following 2008 could precipitate a rise in nonperforming loans in the coming years and trigger a financial crisis. Under this scenario, we think the government would absorb losses because it owns the majority of the banks. However, disruptions to credit flows and much tighter lending standards—a knee-jerk reaction to any financial crisis—would cause growth to slow to 5% in 2014 and trough at 3.2% in 2015.
Fred Gibson
is an Associate Economist at Moody's Analytics.
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