FXStreet (Mumbai) - New Macro Prudential Assessment system, or MPA , announced by the PBoC on 29th December will be used more as a lever for enforcing financial stability and not merely as a tool used to increase or remove liquidity from the system. The objective is to control risk factors. The central bank stated that while calculating ratios for individual banks, their stock and bond markets exposure will be considered. Growth in lending, rates on loans and capital adequacy are the other factors that will be looked at. Banks are required to put aside a percentage of their deposits that they can’t lend out. This is the required reserve ratio and an increase or slash of this ratio impacts cash supply in the banking system. Currently, the central bank pays a 1.62 per cent annual interest rate on banks’ required reserves and 0.72 per cent on extra reserves parked at the central bank. In its announcement last week, the PBoC declared that it will use the MPA system to assess banks’ capital adequacy as well as to check financial institutions’ interest-rate pricing. The central bank said it will assess data on a quarterly basis. It will however provide guidance to banks on a monthly basis. The PBOC beleives the assessment “will change its focus from loans, which are narrowly defined, to a focus on credit in a broader sense.” China’s top leaders in December mentioned that in 2016 monetary policy would be more “flexible” to boost structural reform. The introduction of the new MPA system seems aligned to this objective. Mao Junhua, an analyst at China International Capital Corp. in Beijing feels that he upgraded mechanism will provide the central bank with "more macro-prudential regulatory powers”. Are more RRR cuts unlikely? This decision of the PBoC to implement MPA likely implies lesser cuts in required reserve ratio to increase lending in the economy. On the very first trading day of 2016, a 7 per cent selloff in the CSI 300 Index caused stock trading to be suspended in China for the first time. The central bank’s damage control initiative taken this morning helped stocks to recover slightly. The PBOC injected liquidity worth 130 billion yuan ($19.9 billion) into financial system with the objective to soothe nerves of jittery investors. Ming Ming, head of fixed income research at Citic Securities Co. in Beijing sees “less across-the-board cuts" in the RRR. Ming Ming further explains "The MPA framework signals policy makers will move away from universal reserve ratio changes to being in favor of using the tool to fine-tune requirements for individual banks." The MPA is in tune with the intention of the officials to be more flexible with monetary policy tools. China, it must be remembered is trying to execute economic reforms while not compromising on growth. Ma Jun, the chief economist of the PBOC’s research bureau, is of the opinion that the short-term interest rate stability must be considered by the PBoC while deciding upon reserve requirements. Ma also underlined open market operations and other measures to manage rates. If PBOC’s Ma’s statement is studies it will be evident that China is looking at more customized RRR adjustments and fewer across-the-board changes. These comments caused China’s 10-year bonds to drop the most in two weeks as doubts related to the easing of lenders’ required-reserve ratios began to surface. Why more RRR cuts are required? Chinese policy makers had in October reduced he ratio to 17.5 per cent from 18 per cent, well below the 2011 peak of 21.5 per cent. They had also lowered the one-year lending rate to a record low 4.35 per cent. The objective was to spur growth in a slowing economy. According to the median estimates of economists surveyed by Bloomberg, the pace of expansion will likely slow further to 6.5 per cent in 2016 and 6.3 per cent in 2017. A liquidity crunch seems evident as capital outflows continue. These factors may compel the PBOC to increase money supply. The official China Securities Journal, an affiliate of Xinhua News Agency reported that some market participants believe “additional RRR cuts are necessary and feasible”. For more information, read our latest forex news.