China orders foreign banks to hold yuan in reserve

China will require foreign financial institutions in the country to hold yuan in reserve, the central bank said today as it seeks to stabilise the currency, which has been hit by capital flight.

Until now, overseas banks in China have been set a reserve requirement ratio – the amount of depositor funds they must keep aside – of zero.

From next week they will be subject to similar rules as domestic lenders, the central People's Bank of China (PBoC) said in a statement, without specifying the percentage to be retained. Major Chinese banks currently have a ratio of 17.5%.

The PBoC said the move aimed to "prevent financial risk and protect financial stability", according to a statement on its website. It added the rules will "strengthen liquidity management".

The announcement came as the yuan weakens on worries over a slowdown in the world's second largest economy, which has caused capital flight and a widening gap in the offshore market, where investors are betting on further falls.

Offshore dealings in the yuan – also known as the renminbi – are free from the strict capital controls that China imposes domestically, making it operate more like a true market.

"The central bank wants to maintain the stability of the yuan rate because the expectations of depreciation have been rising," Nomura International China economist Wendy Chen told AFP.

"The move will impact the liquidity of offshore renminbi, so it can narrow the price gap between the offshore and onshore rates and therefore lessening the room or chances for foreign institutions to short the yuan," she said, referring to a bet that the currency will move lower.

The yuan strengthened in offshore trading on Monday on the announcement, rising 0.41% to 6.5868 per US dollar in Hong Kong, Bloomberg News reported.

The central bank today fixed the yuan higher against the greenback at 6.5590. At midday, the yuan was quoted at 6.5780 in onshore trading, strengthening from Friday's level.

The central bank uses the reserve ratio to help adjust monetary policy, similar to raising or lowering interest rates.

The new rules will not apply to foreign central banks, international financial institutions and sovereign wealth funds, the PBoC statement said.