On November 3, it was learned that in order to strengthen foreign exchange liquidity management at financial institutions, the People's Bank of China has decided to raise the foreign exchange deposit reserve requirement ratio for financial institutions by 2 percentage points, effective November 15, 2026, increasing it from the current 4% to 6%.
The FX deposit reserve requirement ratio is an important macroprudential tool for managing cross-border capital flows and exchange rate expectations. Industry experts noted that this marks the first time in nearly five years that the central bank has raised the FX deposit reserve requirement ratio. According to Wen Bin, chief economist at Minsheng Bank, the central bank's most recent adjustment to the FX reserve requirement ratio was on September 15, 2023, when it was lowered from 6% to 4%; the last time it was raised dates back to December 15, 2021.
Wen Bin pointed out that the mechanism of the FX deposit reserve requirement ratio is similar to that of the RMB deposit reserve requirement ratio. Raising this ratio means banks must deposit more foreign currency funds with the central bank, reducing the amount of US dollars available for lending, investment, or sale in the domestic market, thereby tightening domestic US dollar liquidity, increasing the cost of holding excess dollars, and indirectly curbing the incentive to convert foreign exchange and easing pressure for RMB appreciation.
"This increase in the FX deposit reserve requirement ratio will appropriately raise the cost for financial institutions of holding foreign exchange funds, reduce the foreign exchange funds available to financial institutions and tighten the foreign exchange liquidity that can be directly injected into the market. It will help curb one-sided exchange rate expectations, herd behavior, and pro-cyclical trading, and enhance two-way fluctuations in the RMB exchange rate," said Pang Ming, a member of the China Chief Economist Forum.
Regarding the policy backdrop, Wang Qing, chief macro analyst at Orient Finance, said it was mainly because against the backdrop of a rising US dollar index recently, the pace of RMB appreciation against the US dollar has clearly accelerated, and one-sided appreciation expectations have gathered to a certain extent. Wen Bin noted that since mid-September, the US dollar index has risen about 3%, climbing from below 99 to around 102, while the RMB has continued to strengthen one-sidedly against the US dollar, breaking through 6.65 yuan on November 2 to hit a more than four-year high. Correspondingly, the CFETS RMB exchange rate index rose from 101.49 on September 11 to 103.77 at the end of October, an increase of more than 2%. At the same time, the foreign exchange settlement rate in the FX market has also rebounded noticeably, from 57.2% in July to 65.3% in September.
Wang Qing pointed out that historically, adjustments to the FX deposit reserve requirement ratio have come in two magnitudes, 1 percentage point and 2 percentage points, mainly depending on the need for foreign exchange market adjustment. This 2-percentage-point increase represents a relatively strong policy move. The central bank's action sends a clear policy signal to curb the excessive pace of RMB appreciation and cool one-sided appreciation expectations in the market. Pang Ming believes that China's overall balance of payments remains resilient and the foreign exchange market is generally stable.
In the long run, Zhao Qingming, chief economist at Beijing Longhe Investment, said raising the FX deposit reserve requirement ratio will freeze more foreign exchange funds in the banking system, help balance foreign exchange supply and demand, and achieve long-term relative stability of the RMB exchange rate. "It is expected that regulators will continue to adhere to a market-based exchange rate formation mechanism while comprehensively using macroprudential management tools and expectation management measures to keep the RMB exchange rate basically stable at a reasonable and balanced level," Pang Ming said.
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