UPDATE 2-Hong Kong to allow banks to borrow yuan funds from swap line

By James Pomfret and Victoria Bi

HONG KONG, June 14 (Reuters) - In a move to increase the supply of yuan funds in Hong Kong, authorities said on Thursday that they would allow banks in the city to borrow yuan term funds from a swap line with China's central bank.

With effect from June 15, the Hong Kong Monetary Authority will provide yuan funds against necessary collateral to banks involved in offshore yuan business, the territory's de-facto central bank said in a notification posted on its website.

Being China's premier offshore yuan centre, the swap line between Hong Kong and the People's Bank of China is the biggest at 400 billion yuan ($62.8 billion) among the many swap lines Beijing has signed with various central banks across the world.

"The facility would serve to address short-term yuan liquidity tightness which may arise from time to time, for example, due to capital market activities or sudden need for yuan liquidity by Participating AIs' overseas bank customers," Peter Pang, deputy chief executive at the HKMA, said in a statement.

The move underscores Hong Kong's commitment to Beijing's plan to use the financial centre as a test bed for its growing efforts to internationalise the yuan.

"It would help reduce potential market disruptions and hence enhance market confidence at all times and support the long-term development of the offshore RMB market," he said.

Retail investors and companies have been drawn to the yuan and a spate of new yuan-related investment products in recent years on expectations that Beijing would continue to let its currency appreciate against the U.S. dollar.

But retail interest has waned in recent months as the yuan weakened to near six-month lows.

At end-April, yuan deposits in Hong Kong banks were around 552 billion yuan ($87 billion), compared to a peak of 627 billion yuan in November, government data showed.

INCREMENTAL STEPS

In separate news on Thursday, sources told Reuters that Hong Kong was set to announce measures to boost liquidity in the offshore yuan market, after renminbi deposits at the city's banks fell for five months in a row.

The measures would include increasing the daily yuan conversion quota for Hong Kong residents from 20,000 yuan ($3,100) and raising their daily transfer quota to mainland Chinese banks from the current level of 80,000 yuan, the two sources with direct knowledge of the situation said.

Traders said the moves are likely to be incremental at best as corporate deposits are the key driver for offshore yuan business and not retail funds.

While retail investors have grown discouraged, institutional players have not shown similar signs of losing patience with the offshore yuan market. Yuan-denominated bond sales have kept growing at a robust pace.

After suffering a decline in the closing months of 2011, average monthly issuance of so-called "dim sum" bonds so far this year is a healthy 11.3 billion yuan compared to 8.5 billion yuan in the last quarter of 2011, Thomson Reuters data showed.

The Chinese currency's weakness in the offshore yuan market has lagged a fall in the non-deliverable forwards space because of a spreading cash squeeze in Hong Kong.

Among the reasons cited for the decline in yuan deposits in recent months are an increased pace of fund flows back into the mainland because of easier cross-border flows and the launch of various investment schemes such as RQFII.

The explosive growth in CNH funds was led by a landmark agreement between the HKMA and the People's Bank of China in July 2010.

Prior to that scheme, Hong Kong residents could convert their savings into 20,000 yuan daily. Between 2004 and early 2009, the share of yuan deposits in the Hong Kong banking system stagnated well below the 1 percentage point mark.