After the People’s Bank of China (PBoC) released its "new three arrows" on September 24, i.e., monetary, fiscal, and structural, it took a series of actions. On one hand, the central bank decided to establish the Securities, Funds, and Insurance Company Swap Facility (SFISF), with an initial operation scale of RMB 500 billion, aimed at providing high liquidity support to securities investment institutions. On the other hand, the PBoC and the Ministry of Finance held a joint meeting to establish a working group for the buying and selling of government bonds, setting up an operational mechanism for this group. Both of these measures indicate that the central bank's monetary policy operations are beginning to penetrate into the capital markets, such as the stock and bond markets, with the hope of exerting policy influence through both direct and indirect market participation.

As clarified by the PBoC, the structural tools for the stock market are essentially "swap agreements" where low-risk, high-liquidity government bonds and central bank bills are exchanged for equity assets from securities investment institutions, without increasing the base currency. In fact, the central bank's buying and selling of government bonds in the secondary market is not a means of injecting base currency either. From a policy perspective, these practices are primarily aimed at short-term liquidity adjustment in the capital market and achieving precise control of interest rates. Compared to traditional aggregate policy measures like reserve requirement ratio cuts and interest rate reductions, the effects differ significantly. Currently, the scale of these operations is limited, with structural tools related to the stock market amounting to about RMB 800 billion, while the central bank reported net purchases of around RMB 200 billion in government bonds in September. However, PBoC governor Pan Gongsheng has mentioned that the quota for structural tools in the stock market can be expanded. Additionally, as the issuance of ultra-long-term special government bonds increases, their role as intermediaries in the bond market will also expand, consequently increasing their impact on long-term market interest rates.

Researchers at ANBOUND believe that PBoC's new measures and tools are a response to the increasingly prominent issues of quantitative to qualitative change in China’s monetary and financial environment, in addition to the liquidity trap. As the effects of interest rate cuts and reserve requirement ratio reductions weaken, and the space for monetary policy narrows, the central bank aims to achieve more precise and effective monetary issuance through structural targeted adjustments. This means that as the efficiency of traditional monetary transmission through indirect financing markets declines, PBoC seeks to operate in direct financing markets, such as the stock and bond markets, to make interest rate adjustments more precise and structured. Furthermore, this is also to guide expectations and enhance the efficiency of monetary transmission through demonstration effects.

Since the central bank's announcement on September 24, though these policies have yet to be implemented, they have already signaled a new rally in the A-share market, briefly improving capital market expectations. However, the incremental impact is limited, and the underlying market conditions for enterprises and investors remain unchanged, leading to a lack of sustainability in the central bank's market interventions. Since October, increased volatility in the A-share market may be a "side effect" of these precise adjustments. While direct interventions can guide the market, they may also distort it and lead to "overshooting" by investors, thereby increasing risks. As noted by researchers at ANBOUND, this "precise control" is challenging and requires high expertise, as it could heighten speculation and amplify market risks, warranting a cautious approach.

Researchers at ANBOUND are also of the opinion that the PBoC's direct market interventions blur the lines between indirect and direct financing, as well as between fixed-income and equity markets. This will further promote the mixed development of the financial industry from both policy and regulatory perspectives. ANBOUND’s founder Kung Chan emphasizes that for a long time, prohibiting bank credit funds from entering the stock market has been a fundamental national policy, which still remains stressed today. As the trend towards financial mixed development progresses, existing separations in the policy framework are breaking down. While this can enhance coordination and overall effectiveness across markets, it also raises concerns about risk transfer between different sectors. The ability to monitor these interactions comprehensively under mixed regulation remains questionable. The lessons from the 2008 subprime crisis in the U.S. illustrate that while financial products may seem to mitigate risk, those risks can still permeate the entire financial system, and excessive leverage can amplify them, potentially leading to systemic crises.

Chan noted that while these new policies have various constraints and limitations, they fundamentally open up the channel for bank funds to flow into the capital market. Once the gates are opened, this will inevitably release a significant amount of capital. This may lead to visible short-term effects, but the underlying issues are clear, i.e., the problems within banks are tied to national stability. If the deterioration of large banks' balance sheets becomes fully apparent, it could pose serious risks, as the monetary policy may struggle to bear such a burden.

Chan also emphasizes that the monetary system is a complex macro-level entity, making true "precision" in adjustments largely unrealistic. The interconnectedness of such a system means that changes can have widespread effects, introducing significant risks. The central bank's direct or indirect market interventions increase potential risks in specific areas and raise the likelihood of unpredictable situations. In the context of mixed financial development, risks are not easily isolated and often concentrated in weaker sectors. Relaxed macro policies can generate leverage that accumulates risks in different forms. As a result, this complex approach to monetary policy, although it may appear effective, could result in uncertain long-term consequences.

Final analysis conclusion:

The new liquidity tools established by China’s central bank for the capital market, along with the implementation of new monetary policy instruments such as direct government bond transactions, indicate that monetary policy operations are shifting towards "precise adjustments" in the stock and bond markets. While these measures may have noticeable short-term effects, they also contribute to market volatility. In the long run, their promotion of financial conglomeration implies a concentration of risks. This refined and structured policy approach carries a significant degree of uncertainty.

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Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.