China Lifts Banks' Reserve Ratio

China moved again to head off inflation by requiring banks to hold more of their deposits in reserve, the eighth such move since November, despite little evidence that measure is taming prices and worries that it is depriving needy smaller companies of capital.

The 0.5-percentage-point increase in the reserve requirement ratio was announced after China reported inflation hit 5.3% in April, with food prices galloping at 11.5%, the sixth straight month in which food prices have risen at double-digit rates.

The inflation figures were slightly lower than in March, but still represented a significant risk that the authorities haven't put a lid on inflationary pressures. And there were other worrying signs: A higher number of bank loans than expected in April, at $112 billion, and a wider-than-expected trade surplus of $11.4 billion, up from $139 million in March, meant more cash flooding into the economy, increasing the need to soak up liquidity.

Unlike most major economies, China uses reserve requirements as its first line of defense against inflation, figuring the tool will make it tougher for banks to lend and thus cool an overheating economy. When the move takes effect on May 18, China's largest banks will face a 21% reserve requirement, among the highest in the world. By comparison, the U.S. reserve requirement is 10%.

Still several more reserve-rate requirements are in the works, which could bring the ratio to as high as 23%.

Squeezing the banks has a variety of unintended consequences, including encouraging banks to skirt the requirements by lending in ways that aren't covered by the regulations—thus reducing the anti-inflationary effect of reserve increases. Chinese banks have been especially aggressive in trying to attract deposits so they can continue lending, fueling a proliferation of lightly regulated wealth-management products. That may potentially cause headaches for regulators down the road.

The requirements also tend to hit smaller banks much harder than larger ones and to crimp lending to small and medium-size enterprises, instead favoring huge state-owned companies.