China slashes RRR by 100bps

The market only expected a 50bps cut.

China's central bank recently announced that the reserve requirement ratio (RRR) will be lowered by 100bps for all deposit-taking institutions.

According to a research note from Barclays, the magnitude of the RRR cut was larger than the expected 50bps by the market.

In addition, the People's Bank of China cut the RRR targeted at financial institutions supporting small enterprises, rural areas and major water construction projects.

Collectively, Barclays estimates these cuts could release about RMB 1.2-1.4tn liquidity. Barclays believes the cut is mainly to counter significant capital outflows in March when FX reserves declined by RMB 231bn, the most in 14 years.

These RRR cuts should be only marginally positive to banks' earnings (by 0.92% for 2015E net profit on average, all else being equal), on Barclays' estimates, but should be positive for market sentiment, in Barclays' view.

Here's more from Barclays:

Full-blown RRR cut of 100bps together with additional targeted RRR cut for SME/rural-oriented banks - The PBOC announced on 19 April 2015 that effective from 20 April, the RRR will be lowered by 100bps. After the cut, the effective RRR will be 18.5% for large banks and 16.5% for small- and medium-size banks.

In addition, to increase support for small enterprises, rural areas and major water construction projects, the central bank also decided to further lower the RRR by 1) another 100bps for rural cooperatives and rural banks; 2) another 200bps for China Agricultural Development Bank; 3) another 50bps for state-owned banks and joint-stock banks whose small enterprise loans mix exceeds certain threshold and.

Collectively, we estimate that the full-blown and targeted RRR cut will release about RMB 1.2-1.4tn liquidity into the banking system.

Larger-than-expected RRR cut likely to counter capital outflow - Although RRR cut has been well expected, the magnitude of 100bps RRR cut in at one time instead of 50bps came as a surprise to the market.

We believe the main reason for such a RRR cut is to reduce liquidity outflows. According to the PBOC, FX reserve declined by RMB 231bn in March 2015, the largest single-month decline since the data became available in January 2000 on our calculation.

The significant decline in FX reserve resulted in M2 growth of 11.6% y/y in March, lower than the target of 12% set by the regulator. Our China economist team expects two more 50bps RRR cut in 2015 (click here for more details).

Marginally earnings beneficial but sentiment positive - We estimate that the RRR cut should be slightly positive for bank earnings. Yield could be enhanced by swapping low-yield RRR into market rate bonds.

However, the overall market interest rate could drop post the liquidity loosening. We estimate NIMs and net profits could be slightly lifted by 1.6bps and 0.92% on average for the banks in 2015 all else being equal.

Although the RRR cut could support overall sentiment as well as bank shares, we expect to see a more volatile market after H-share China banks rallied by 21% in average in the past month, in our view.