Central bank asks lenders to utilize special policy tools, shore up real economy

China's central bank has urged banking financial institutions to increase credit supply to smaller businesses.

That can be done now given the current special monetary policy tools and market funding, the People's Bank of China said in a message on Monday.

Enhanced credit to small businesses will help maintain financial support to the real economy, the PBOC said.

Banks are encouraged to use relending and rediscounting instruments to boost loans, as well as expand funding resources by issuing special bonds, it said.

The PBOC also called upon lenders to scale up inclusive financing services, and continually increase credit to small and micro enterprises, particularly those availing bank loans for the first time.

By the end of the first quarter, China's outstanding loans to small and medium-sized enterprises, or SMEs, were up by 33.9 percent year-on-year. This suggests monetary authorities' efforts to persuade large State-owned commercial banks to increase such loans by more than 30 percent this year may be on the right track, Moody's Investors Service said in a research note.

But, extending more loans to SMEs might make rural commercial banks vulnerable as the latter have smaller buffers to withstand bad loans, said Nicholas Zhu, an analyst with Moody's.

Meanwhile, the central bank asked financial institutions to tighten regulations governing cross-region lending through internet-based platforms.

It also banned competition among banks to increase deposits through offers of higher deposit rates, a measure to reduce credit costs for small and medium-sized banks.

Continued tightening of supervision of vulnerable regional banks could hamper their loan growth in the next four to five quarters, Zhu said.

"Overall, Chinese banks' asset quality and capital will be stable over the next 12 to 18 months as the economy continues to recover."

As well, given the uncertainties in the economic environment due to the COVID-19 pandemic, the PBOC urged the banking sector to "have higher tolerance" for nonperforming loans.

At the latest quarterly monetary policy meeting, the PBOC sought to ensure sufficient liquidity in the market to accommodate temporary volatility.

Some analysts said the policy appears to have steadily returned to a neutral stance.

Others, however, thought liquidity may become a concern in the second half of this year as local governments in China are expected to accelerate their bond issuances. By the end of June, they had sold about 30 percent of the full-year quota.

This month, the PBOC has already injected 40 billion yuan ($6.19 billion) through reverse repos to stabilize liquidity. In June, it increased net liquidity by 200 billion yuan through the medium-term lending facility or MLF.

"As corporate revenues and household incomes recover, regulators should normalize loan classification and provisioning rules as planned, to ensure banks properly recognize non-performing loans and hold adequate capital and liquidity buffers," said Sebastian Eckardt, lead economist for China at the World Bank, in a recent interview.

Eckardt suggested policymakers should adopt macro-prudential measures to curb excessive leverage as well as take steps to improve the efficiency of financial intermediation, in order to ensure capital flows to productive investments and enterprises.

"The monetary policy support is receding, even in the absence of official policy rate adjustments," said Fitch Ratings in its updated sovereign rating report for China.

In Fitch's view, China's credit growth has slowed to a level below nominal GDP growth in May.

This implies the economy-wide leverage ratio will nudge down this year, having spiked to about 270 percent of GDP in 2020, Fitch said.

"The authorities have signaled a desire to reprioritize pre-pandemic financial de-risking measures, but with credit-sensitive areas of the economy decelerating, it remains to be seen whether tighter policy settings will endure."