By Hu Rongping (胡蓉萍) and Zhao Juan (赵娟)
Issue 625, June 24, 2013
News, page 1
Translated by Siu Tan
Original article: [Chinese]

After a sleepless night, a trader with a mid-sized Chinese bank went to work on a Friday in late June worried about how he would pay back the overnight loans that his bank had borrowed the day before. Updating his social media account, the trader said that "My first and only task today is to liquidate the debts, and after that there'll be meetings, meetings and then more meetings."

Just one day earlier, the Shanghai Interbank Offered Rate or Shibor (上海银行间隔夜拆借利率) increased to 13.44 percent, exceeding even the highs posted during the financial crisis in 2008 and setting a new record high for the decade.

A temporary shortage of capital swept through China's financial markets and most financial institutions rushed the market to locate funds. Investment managers, financial analysts and even the administrators charged with regulating the system were all asking the same question:

"Do you still have money?"

In fact, China's Central Bank suggested that the Industrial Commercial Bank of China (ICBC), Agricultural Bank of China (ABC) and three other large state-owned banks step in and start lending again in order to add liquidity to the market, according to what a source at one of the large state-owned banks told the EO.

Another person working in the banking industry told the EO that executives from the Postal Savings Bank of China (中国邮政储蓄银行), the lender with the most ample holdings of funds, were called to meetings with the People's Bank of China (PBoC) three times and were also called to meet with officials from the China Banking Regulatory Commission (CBRC) in a bid to persuade them to release more funds into the market.

Of course, just because authorities are directing the big banks to start lending funds again doesn't mean that the central bank will change its current policy stance of not releasing additional liquidity into the money markets. Various authoritative sources in the banking industry told the EO that this policy stance is likely to remain in place for a while yet.

Since late May, China's interbank lending market began to show signs of tightness and the pressure has gradually been rising since then.

By June 20, the tightening in the market reached a tipping point which traders have started referring to as the "June 20 massacre" (六廿惨案).

Overnight and 7-day lending rates reached 10-year highs, surpassing the levels registered during the height of the financial crisis in 2008. For a while there the rates on the interbank market resembled those on China's grey lending market.

"Over the recent period, some banks have been over optimistic about their cash flows, and they didn't consider a series of facts that would affect the liquidity of the market in June. Therefore, without effective responses, and lack of the help from primary dealers like large banks, the price of funds in the money market fluctuated widely." Zhang Xiaohui (张晓慧), an official with China's Central Bank, explained on June 19.

According to Zhang, facts that affected the liquidity of the current market included banks having to put aside funds to meet reserve requirments (备金补缴), tax payments (税款清缴), a spike in the amount of cash that needed to be made available over the holiday period (假日现金投放), foreign currency positions (外汇头寸), and an increase of debts and dividends payments to foreign companies.

These factors were the main reason for the lack of liquidity in the interbank market in mid-June.

However, Zhang also made a point of emphasizing that "Some banks have been relying on large scale lending from other banks on the wholesale market but there were serious problems in terms of a mismatching of maturity, this brought a lot of pressure on the management liquidity."

China's interbank market was forced to grow up overnight. Traders suddenly realized that "the central bank can 'stop breast feeding,' and that wouldn't continue to provide ample liquidity forever."

The Central Bank, which up until now was often jokingly referred to as "central mother" (央妈) had suddenly changed into a ruthless "stepmother" (后妈).

The Weaning Time

The problem of tight liquidity in inter-bank market has occurred several times since 2009, mostly during periods when cash is tight (钱荒时期), like at the end of the year. In the past the Central Bank could more or less be relied on to provide funds to help balance the market.

But it didn't this time.

A trader from BOC commenting on his Weibo, stated that the unusual response from the Central Bank might be a sign of a new era for the inter-bank market.

Over the past few years, the Central Bank has become the funding source of last resort for commercial banks. However, as no specific interest rate target was set, the macro control normally ended up like a psychological game between Central Bank and commercial banks.

"It seems that the Central Bank is currently unwilling to pump in liquidity," said Zhu Xialian (朱夏莲), director of Fitch China (惠誉中国金融评级).

According to Ms. Zhu, without change of current policy, the overnight interest rate is likely to rise until July when various financial products are set to reach maturity.

According to Fitch China, medium-sized banks have weaker liquid assets compared to the larger banks, and normally need higher loan payback rates to cover their short-term cash outflow.

"It puts greater pressure on medium-sized banks to payback their debts," Zhu said.

Over the past three years, mid-sized banks have been more aggressive in the marketing of various financial products.

The Financial Times (金融时报), a Chinese-language daily newspaper sponsored by Central Bank, published an article on June 17 that predicted that a liquidity crisis is unlikely to occur in the Chinese money market. The paper argued that the financing problems with some banks was due to the excessive faith in short-term inter-bank loans and excessive lending that surpassed the limits set by regulators. Therefore, banks should be able to solve the liquidity problem by themselves, instead of relying on the Central Bank.

However, after this article appeared, various people working in China's financial sector began to give warnings that things could go awry.

"The risk of contracts between banks not being honored may increase due to the tension in the inter-bank lending market," said an analyst from a financing company in East China, "Although this has only occurred at a few individual banks, we have to be careful about the systemic risks that could follow if a chain of contracts were to be broken by many banks."

It was worth noting that after a stressful morning on June 20, there was a certain amount of money injected into the market which helped some banks with their emergency needs.

It ignited the market’s speculation that Central Bank had injected money in large banks, or it had authorized large banks to lend money with lower rates to stop rates from rising too far.

Did the Banks Miscalculate?

"Some banks thought the government would launch expansionary fiscal policies, so they arranged and held their places in advance,” PBoC official Zhang Xiaohui explained during a meeting on June 19.

All of China's banks issued almost a trillion yuan in new loans during the first 10 day in June. More than half of the 24 major banks exceeded the monthly loan issuance limits for June in those first 10 days of the month.

Loans issued by the Postal Savings Bank of China (中国储蓄银行) exceeded 100 billion yuan. CITIC Bank (中信银行) issued over 50 billion yuan, while China Minsheng Bank (民生银行) and Ping An Bank (平安银行) both issued more than 30 billion yuan in loans.

It seemed that all these commercial banks had made an error of judgement.

In fact, their liquidity problem was caused by their misjudgment about the Central Bank's behavior and their faith that the loose monetary policies would continue.

However, some in the market still have hopes that the central bank will step in to saw them.

One bank trader told the EO that "If the central bank spoils her 'children' over a long period of time, this will cause moral hazard or even plant the seeds of systemic risk. However, as Shibor plays such a vital role in China's money markets, and given that all the major institutional players now face such an unusual level of fluctuations in the market, should the central bank continue to sit on the sidelines doing nothing?"

According to Central Bank, the spike in lending rates on the interbank market on June 20 was largely the fault of the commercial banks many of which had not handled their liquidity management duties well.

As one person who was sympathetic to the central bank's position put it "on what basis do you want them to add additional liquidity, you'll simply take the money and won't do the right thing with it again."

It was not the Central Bank’s intention to increase the inter-bank lending rates to such an incredibly high level.

According to Chen Yuyu (陈玉宇), a professor from the Guanghua School of Management at Peking University, by allowing rates to go so high the Central Bank could set off a repayment crisis between banks and that this was playing with fire.

The financial markets have become more complex and for a long time now the financial institutions involved are not restricted to a few state-owned banks. The Central Bank also doesn't have any experience in stabilizing the inter-bank market or in ensuring that banks meet their repayment obligations. It's never had to face this kind of challenge before.

The Central Bank's position has also received some supporter from those working at commercial banks. An employee with Zheshang Bank (浙商银行) told the EO that "Most of the newly issued loans have indeed just been churned around. The increase in funds has all gone to interbank lending, the banks are playing amongst themselves with money. This bout of tightness in the money markets and the Central Bank's decision not to release more funds is a warning to banks, that banks should direct funds into the real economy."

This echoes recent statements from China\'s State Council and the head of the CBRC on the need to ensure that funds are directed towards the real economy.

“If the situation continues for another couple of months, lots of companies on the edge of bankruptcy will fail; if it continues for half a year, the market will face a risk of asset bubbles and a hard landing, and cause irreversible consequences. Is the current attitude for real or are they prepared to back down?” asked Shi Lei (石磊), vice president of Fixed Income Division at Ping An Securities (平安证券).

Zhang Xiaohui urged all the larger banks to strengthen their liquidity management. “Banks should adjust their expectations about the liquidity of the market, reinforce the study of impact factors, and improve their liquidity management. Besides, large banks need to play their roles as stabilizers, and report any major suddenly-occurring issues to the Central Bank. If procuring funds is causing problems for banks, they can request help and cooperation from the monetary and credit department of the PBoC. As long as there is a systemic risk and all the banks have done what is expected of them, then the Central Bank will support them."

Due to the tax payment schedule of some firms and banks deposit reserves becoming due in early July, the market will continue to face difficulties in July.

In terms of future monetary policy, Zhang Xiaohui suggests that banks familiarize themselves with future macroeconomic policy.

"The future challenges to the economy can no longer be solved through expansionary policies and there will be no change to the current "prudent" monetary policy settings - they won't be loosened or tightened. The emphasis will be put on the following five principles: "stable policy, optimizing the economic structure, improving service, avoiding systemic risk and deepening reforms."