China's c.bank inflicts pain on banks to rein in credit

Thu Jun 20, 2013 8:19pm EDT

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SHANGHAI, June 21 (Reuters) - The Chinese central bank's
determination to rein in rapid credit growth has sent interbank
interest rates to record highs, creating panic and rumours of
possible default as some banks scramble to secure short-term
funds.
    China's overnight repo rate - the interest rate for
interbank lending that keeps markets liquid - climbed to levels
reminiscent of the global credit market freeze that preceded the
collapse of Lehman Brothers in September 2008.
    There has been panic in some parts of the money markets in
Chinain particular among some small financial institutions that
were highly indebted, traders said. But the People's Bank of
China (PBOC) has been standing firm, refusing to bow to pressure
to flood the interbank market with more cash.
    "The Chinese banking system's current liquidity scramble is
a regulatory/policy choice. A squeeze by fiat," Australian bank
Westpac said in a note.
    The PBOC told the market it would not conduct repo business
in its regular open market operations on Thursday, frustrating
widespread expectations it would use reverse repos to inject
cash to ease an acute market squeeze. 
    Traders said the central bank appeared determined to force
banks and other financial institutions to reduce their own debt
burdens.
    In particular, the government wants to clamp down on
non-essential businesses by financial institutions, such as the
widespread use of wealth management products.
    Banks create these products by packaging together assets
such as money market deposits, corporate bonds and informally
securitised bank loans. They market the products to customers as
higher-yielding alternatives to traditional deposits.
    In addition, China has tens of thousands of non-bank lenders
that are providing increasing amounts of credit to businesses
and government outside the mainstream, regulated banking sector,
a situation that is stoking systemic risk, credit rating agency
Fitch said this month. 
    Japanese bank Nomura said it believed China's new leaders,
who took office in March following a generational leadership
change, were fully aware of the financial risks in the economy.
    "As their tenure will last for 10 years, they are willing to
tolerate some short-term pain in order to achieve long-term
policy objectives - preventing financial crisis and delivering
sustainable growth," Nomura said in a note.
    Some defaults would likely occur in the manufacturing
industry and in non-bank financial institutions in the coming
months, Nomura added.
    
    SQUEEZE BEGAN EARLY IN JUNE
    The money market squeeze that began early this month has
worsened this week, forcing banks and other financial
institutions to trim non-essential businesses, traders said.
    The market has recently been hit by heavy demand for funds,
including from the approach of the quarter-end, when banks need
more cash to meet regulatory checks and to boost reported
deposit totals in their quarterly reports to shareholders.
    If money market rates remained high, it could translate into
higher financing costs for businesses, economists said.
    A full-blown crisis is unlikely as liquidity is expected to
improve significantly from mid-July, after the seasonal effects
of the quarter-end fade and a large volume of maturing PBOC
bills and government bonds injects cash into the market, traders
said.
    On Thursday, the benchmark weighted-average seven-day bond
repurchase rate jumped a whopping 380 basis points to a record
high of 12.06 percent, while the overnight repo rate  surged 598
bps to 13.85 percent. 
    Strong credit expansion has failed to trickle down to the
real economy, partly due to excessive factory capacity.
    Indeed, a preliminary survey showed on Thursday that China's
factory activity weakened to a nine-month low in June as demand
faltered, heightening the risk of a sharper second quarter
slowdown. 
    China's economy grew at its slowest pace for 13 years in
2012 and so far this year data has been weaker than expected,
bringing warnings the country could miss its growth target of
7.5 percent for this year, though possibly not by much.
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