SAFE (the State Administration for Foreign Exchange) is a rather obscure state bureaucracy which lies behind one of the biggest economic stories of our time, namely the size and power of Chinese foreign exchange reserves. SAFE holds these reserves as well as being responsbile for drafting the regulations around the use of foreign exchange. The organisation has overseen the renminbi’s gradual move towards convertibility and currently SAFE holds around USD 3.7 trillion in currency reserves.
While this is an impressive figure, SAFE is an merely an agency controlled by the People’s Bank of China (PBOC) which makes the critical financial policy decisions affecting foreign reserves. The PBOC is the Chinese central bank, similar to the Federal Reserve or Central European Bank, it controls monetary policy, setting interest rates as well as regulating banks and insurance firms in the country and has overall responsiblilty for financial stability in China.
Let us not forget that by some measures the four largest banks in the world are Chinese. Namely the ICBC, China Construction Bank, Agricultural Bank of China and Bank of China. While these institutions are not as “international” and therefore systemically important as other major banks, they are and will become more important to the global economy.
Recently the Bank has been cutting interest rates in an effort to ward off slowing growth in the economy it also relaxed the reserve ratio requirement for Banks from 18 percent to 17.5 percent, freeing up more funds for lending.
The PBOC also recently provided USD 81 billion in additional funding to the country’s major banks for onlending to industry, in order to complement the interest rate cuts and all part of an effort to prop up a slowing economy.
The PBOC faces a major challenge in a need to crackdown on shadow banking in China and the need to deleverage certain areas of the economy.
The shadow banking system is essentially off balance sheet lending, deposits are put into riskier bank loans and lending is done via trust companies who create “wealth management products” (WMP), these are often invested in high risk areas, such as speculative real estate or just rolling over mature WMPs.
The WMPs allow the banks to avoid the high reserve requirement ratio – which stops banks becoming overleveraged. The WMPs exist thanks to lax regulation, the government is now cracking down on this area, but some fear it is doing it at a time when the economy is already fragile and a clampdown on further lending (although justified) could restrict lending just when it is needed the most.
The PBOC is now one of the world’s most important central banks, but it remains to be seen if it can adapt to a Chinese economy which is slowing, moving away from heavy manufacturing and becoming more exposed to the rest of the world.