* Central bank holds firm in standoff over "shadow banking"
* Seen as deliberate attempt to push through reforms
* Cash conditions remain tight, some borrowers pay very high
By Gabriel Wildau and Jason Subler
SHANGHAI/BEIJING, June 21 China's central bank
faced down the country's cash-hungry banks on Friday, letting
interest rates again spike to extraordinary levels as it
increases the pressure on the banks to rein in rampant informal
lending and speculative trading.
The banks have been using cheap official funds to finance
the vast "shadow banking" market, which Beijing worries is
siphoning credit from industry and creating asset-price bubbles.
The People's Bank of China (PBOC) has tried to put an end to
this over the past three weeks, declining to inject significant
funds into the money markets even as the interest rate for some
banks to borrow short-term funds has soared to 25 percent or
"They are trying to take a different approach to rein in
shadow banking activity," Charlene Chu, senior director at Fitch
Ratings, told reporters on the sidelines of a conference in
"This new approach, where you are trying to tighten the
funding in the system available for that type of credit, is much
more effective, but it is also taking the market by surprise."
Cash remained expensive at least for the smaller banks,
though the weighted average overnight bond repurchase rate
-- a measure of the cost of funds -- fell to
around 9 percent by midday from Thursday's close of 11.62
Some worry the PBOC's hardline approach could be a risky
strategy, creating the potential for defaults and gridlock in
the money markets of the world's second-largest economy, as
happened in the West after the collapse of Lehman Brothers in
Some calm returned on Friday after rumours of some major
banks needing emergency funding were quelled. There was also
market talk the central bank had guided the biggest state
lenders to provide more short-term funds to smaller banks.
The central bank has so far issued no official statements on
the episode. However, sources said on Friday that at a meeting
earlier this week, the PBOC told banks it was not changing its
prudent stance and they should not expect plentiful liquidity
"Some banks were blindly optimistic on the loose liquidity
conditions...," said a banking source who saw internal minutes
of the meeting.
"The central bank gives clear information that they will
keep policy stable without sudden changes in (policy)
direction," added another source, from a state-owned bank, who
also saw the minutes.
In a sign of the problems Beijing is trying to tackle,
shadow-market lending has contributed to a sharp decline in the
dividend the economy gets for each yuan of credit extended.
In 2008, only 22 yuan in corporate fundraising -- mostly in
the form of borrowing -- was required to produce 100 yuan worth
of economic output, according to a Reuters calculation based on
central bank data. By the first quarter of this year, 52 yuan
was required for the same amount of output.
"One consensus among many government officials and policy
advisers is that tough decisions on economic reforms could no
longer be delayed and that taking some short-term pain is
necessary for healthy long-term growth," Barclays economist
Yiping Huang said in a research note on Friday.
China's cabinet this week affirmed its commitment to
reducing financial risks and ensuring that credit growth
supported the real economy.
The central bank is loathe to take actions such as cutting
banks' required reserves to ease the cash crunch, as it is
concerned that might only exacerbate problems such as the high
property prices it is trying to tame.
A flurry of panicked comments on Chinese social media sites
in the wake of the spike in rates and the rumours of emergency
cash injections attests to the risk that any miscalculations by
the central bank could potentially have unintended consequences.
Zhu Jun, CEO of online game developer and operator The9,
posted on his Twitter-like Weibo account an article that laid
out the idea that a financial crisis was at the doorstep, with a
comment already reposted nearly 5,000 times: "This scary article
woke me up. Get ready for a nightmare."