(Yicai Global) Aug. 17 -- After the People's Bank of China restored the foreign exchange risk reserve ratio to 20 percent from zero earlier this month to raise the cost of shorting the yuan, PBOC's Shanghai Head Office has also acted to restrain arbitrage funds from shorting thecurrency again.

PBOC is suspending the implementation of the three net outflow formulas of the Free Trade Accounting Unit in the Shanghai Free Trade Zone, itsShanghai headquarters announced yesterday. Banks are not allowed to deposit or lend yuan funds abroad through inter-bank current accounts, state news outlet The Paper reported.

"Simply put, this policy seeks to reduce the amount of overseas yuan in circulation and thus restrain arbitrage funds from shorting it," said a staffer with the international business department of a major state bank. However, the demand for actual cross-border capital receipt and payment of the real economy must be met and cannot be affected, PBOC also stressed.

The exchange rate of the offshore yuan against the US dollar rallied on Aug. 16 to a high of 6.8549 -- possibly as a consequence of the news -- more than 300 basis points above the onshore market price (the spot rate of the yuan against the dollar).

Based on relevant regulations, the FTUs of China's financial institutions pilot zones may open a special account for yuan settlement only intheir domestic legal person institutions through inter-bank communications for settlement within and across the system. 

Daily management of these account must meet the following conditions (three formulas): the daily closing balance in the FTU settlement accountmust be no more than the multiplication of 10 percent of the net income for the daily settlement balance and macro-prudential adjustment parameter;net cumulative daily closing amounts within one month in the FTU settlement accounts must be no more than CNY1 billion (USD145 million); the cumulative daily balance on a monthly basis in the FTU settlement account must be no more than 0. Of these, PBOC's Shanghai branch formulatesthe macro-prudential adjustment parameters which may be adjusted per capital flow and prudential risk management needs.

Shorting a currency happens when a trader believes it will fall against another and borrows the target currency or uses various forms of options to obtain it and pay it back as it devalues.

Editor: Ben Armour