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China announced this weekend that it was raising reserve requirements for banks by 1 percent, bringing the requirement to 17.5 percent. This is the fifth such hike this year, but it is the first of this magnitude; other increases have been half a percent or less. China said that the increase would be in two stages, with half a percent taking effect June 15 and another half-percent on June 25. The Chinese also said that the increased reserve requirement will not apply to banks in the area affected by the May 12 earthquake.
The Chinese are caught between two massive trends. The first, older trend is the tendency of the banking system, driven by political and social concerns, to make loans that aren’t repaid. The nonperforming loans have been a huge burden on the financial system but have also provided an important service: The loans have kept firms in business that should have gone bankrupt. That has kept the unemployment rate under control — and given the reserves the Chinese have accumulated through exports, they have been willing to live with the nonperforming loans in order to maintain social and political stability.
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