Effective Sunday, the People's Bank of China said the reserve ratio for commercial banks will drop to 6 per cent from 8 per cent. The change will free up about 200 billion yuan (US$24.16 billion), as state commercial banks and other financial institutions reduce their reserves with the central bank, official media reports said.

By cutting the reserve ratio, the central bank is effectively increasing lending margins - a move that should boost banks' profitability, which has been declining in recent years. "With government fixed-asset investment declining, the central bank wants to spur consumption, and stimulate lending to the nonstate sector," said Hu Biliang, a senior economist with SocGen-Crosby Securities in Beijing. The move will also help the central bank save money. The bank now pays 2.07 per cent interest on all deposits it holds for commercial banks. That rate remains unchanged, but by cutting the reserve ratio, the central bank could save up to five billion yuan in interest charges per year, economists estimate.

The move comes as part of a broader set of measures aimed at overhauling the commercial-banking system, whose total bad debt is estimated to exceed $200 billion, or more than 20 per cent of all outstanding bank credit. Those debts were racked up over the past five decades, as banks extended credit to state-runcompanies based on the government's economic plan, regardless of corporate profitability. But as China shifts toward a more market-based economy, the government is paying for the heavy debt burden in the form of slower economic growth. Beijing has ordered state banks to institute tough credit checks, and told bank managers they will be held personally responsible if they fail to halt the rise in bad loans.

Some economists, however, questioned if the lower reserve ratio would lead to a higher quality of loans. "Bank liquidity will increase, but the problem isn't a lack of money," but rather weak demand from quality borrowers, said SocGen's Hu said. Last year, the World Bank called the domestic banking system the weakest link in China's economy, and urged rapid restructuring to prevent a financial crisis. China's commercial banks are all government-owned.

-- The Wall Street Journal