Interbank lending rates in China's money market have soared alarmingly to record highs, prompting fears the banking sector's liquidity problems could spiral into a full-blown credit crunch.
The main driver for tightening credit has been the reluctance of the central bank, the People's Bank of China, to pump cash into the market. This has been seen as a tactic to combat another potentially out-of-control problem - the economy's so-called shadow-banking system and the prevalence of dodgy wealth management products, fuelled by punters wanting a better return than the lower-than-inflation interest rates on bank deposits.
Credit ratings agency Fitch this week warned what many had already suspected, that wealth products worth $US2 trillion of lending were in reality a ''hidden second balance sheet'' for banks, allowing them to run rings around efforts by regulators trying to rein in excessively loose lending.
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The Wall Street Journal reports:
In a sign that China’s central bank isn’t going to relax the pressure on banks soon, the PBOC didn’t add cash to the financial system in so-called open-market operations on Tuesday. It normally conducts open-market operations on Tuesday and Thursday by either extending short-term loans to commercial lenders or getting loans from them, which controls the supply of credit…
…Some big banks are calling for the central bank to inject more cash into the market by lowering the share of deposits that banks are required to set aside against financial trouble, known as the reserve-requirement ratio.
UBS economist Tao Wang says that China’s banks “misjudged” the PBOC.
With the economic data disappointing and inflation low, many in the market had expected the PBC to keep liquidity flowing or ease monetary condition further. However, with the central government apparently more tolerant for slower growth and concerned about financial risks, the PBC seemed to be keen to keep a “prudent” policy stance. The central bank did not carry out reverse repos or initiate short-term liquidity operations as many expected when rates shot up and even faced with a reported case of near default in the interbank market. After the holiday ended last Thursday, PBC again surprised the market by not actively injecting liquidity.
Marketfield Asset Management’s Michael Shaoul says this could be a sign that China’s shadow-banking system is under pressure.
We would therefore conclude that liquidity conditions have started to worsen considerably in recent months despite the fact that credit creation, at least through April, remained at record pace, and were reduced but still buoyant in May. This is perhaps the first sign that the clampdown on wealth management products is having a tangible effect on Chinese liquidity conditions, but we also note that the IPO market for Chinese corporate credit has suddenly started to be much less receptive to new issues, cutting off a second source of “shadow banking”.
Both Wang and Shaoul see the risks of a credit crunch growing, as the PBOC prefers to tackle the risks posed by too much debt even if it means tolerating a slower growth rate.
How much might China slow? On June 13, Nomura’s Zhiwei Zhang and Wendy Chen wrote that there’s a 30% chance that its GDP will fall below 7% during the second half of 2013, in part because of the tight liquidity conditions. They write:
Liquidity tightening can be very damaging to a highly leveraged economy. In particular, many local government financing vehicles rely on new debt issuance to pay the interest on their outstanding debt because they are operating-cash-flow negative. As liquidity tightens, financing costs rise, which may make it difficult to sustain operations. We expect the impact on fixed asset investment and overall growth to show up in June and July data.