After months of debate, China's central bank has decided to cool down loan growth to prevent financial institutions from supporting unnecessary copycat projects and the emergence of an economic overheating.

the People's Bank of China

The People's Bank of China on Saturday announced a hike in rate of reserve requirements -- the ratio for the part of financial institutions' deposits that they must redeposit at the central bank -- from 6 to 7 per cent, effective on September 21.

The central bank said the increase applied to all commercial banks and deposit-taking financial institutions except for rural and urban credit co-operatives, which are undergoing painstaking reorganization.

However, the increase mainly targets commercial banks, which are responsible for the bulk of the credits.

A higher reserve ratio would reduce the funds available for banks offering new loans and is expected to prompt the banks to focus funding on real lucrative projects.

What the central bank would also like to see is that the commercial banks cut back on their support for duplicated projects, which will lead to credit risks for the banks themselves and to structural problems for the economy.

The central bank voiced its intentions to raise the ratio in a May report. The report ignited rounds of debates among economic and business circles.

"Now the relevant government departments agree that money supply is growing too quickly... This will lead to low-quality economic growth and structural problems,'' the central bank said in the statement on Saturday.

New renminbi loans granted during the first seven months of the year totalled 1.89 trillion yuan (US$228 billion), which was more than the total new loans for all of 2002, standing at 1.85 trillion yuan (US$223 billion).

A main reason behind the sufficient fund resources for commercial banks was the rapid growth of the country's foreign exchange reserves, the central bank said. The central bank must buy amounts of foreign currencies with renminbi, with domestic funds eventually going to commercial banks.

With the continuing influx of foreign funds expected for the second half of the year, renminbi available to the banks will abound, the central bank said.

"If we don't take counter measures, credit will continue expanding,'' it said.

The last time the central bank adjusted the reserve ratio was in 1999, when it slashed the ratio from 8 per cent to 6 per cent to help the bank increase financial support for economic growth.

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