On July 9^th, the People's Bank of China decided to lower the deposit reserve ratio of financial institutions by 0.5% from July 15^th, 2021 (excluding financial institutions that were previously subject to a 5% reserve ratio). After this reduction, the weighted average deposit reserve ratio of financial institutions sets at 8.9%.

Since the beginning of this year, the prices of some bulk commodities have continued to rise, and some small and micro enterprises have faced operating difficulties including generally rising costs due to inflation. In order to support the development of the real economy, overall financing costs should be kept in line. Thus, China has demonstrated continuous support for domestic small and micro enterprises.

The RMB reserve requirement ratio (RRR) cut is aimed at inducing more cash in the market. Except for some financial institutions that have implemented a 5% reserve ratio, the reserve ratio is reduced by 0.5 percentage points for all the other financial institutions, and the RRR cut releases about RMB 1 trillion (USD 154 billion) of long-term liquidity. The 5% deposit reserve ratio is currently the lowest among financial institutions in China. Maintaining this low level is conductive to financial institutions' support for the real economy and their own steady operation.

The RRR cut will effectively reduce the capital costs of financial institutions and will also help reduce corporate financing costs for small enterprises.

Does the RRR cut mean a change in the orientation of monetary policy? The relevant person in charge at the People's Bank of China has said that the orientation towards prudent monetary policy has not changed. The RRR cut is a routine operation and later the monetary policy is expected to return to normal. A part of the funds released will be used by financial institutions to return the maturing medium-term lending facilities (MLF), and part of the funds will be used by financial institutions to make up for the tax in mid-to-late July. The liquidity gap caused by the peak period will increase the proportion of long-term funds of financial institutions, and the total liquidity of the banking system will basically remain stable.

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