* Cash crunches seen as PBOC signal for banks to deleverage
* Next squeeze may occur as soon as in late January
* Risk rises as banks build huge interbank positions
* Banks' cash management weakens after tighter liquidity
* Fed's QE taper adds to liquidity supply uncertainties
By Lu Jianxin and Pete Sweeney
SHANGHAI, Jan 8 China's interbank market dealers
are braced for a rocky ride in 2014 as it becomes increasingly
clear that Beijing will tolerate extreme short-term liquidity
squeezes to deter sloppy lending by domestic banks.
The People's Bank of China (PBOC) confounded the market in
December when it allowed a second dramatic rise in short-term
money rates. Previously, many economists had suggested that a
crunch that roiled domestic and global markets in June was a
one-off and the PBOC was unlikely to allow another.
But that theory went out the window when the central bank
again deliberately held back from injecting enough money to
satisfy market demand, and banks saw themselves pay record-high
rates for cash or see their ATMs run dry.
Dealers are now asking if these lessons will get banks to
fall into line on improving their liquidity management.
"Twice-bitten banks should have gotten the message from the
PBOC that they have to deleverage to better manage their cash
flows," said a trader at a Chinese commercial bank in Shanghai.
"But it takes time for banks to carry this out, so periodic
market squeezes will repeat time and again in 2014."
Defending themselves against accusations of irresponsibility
in the aftermath of the mini-credit crises, central bankers have
said there is plenty of liquidity in the system - banks are just
Traders say the next crunch could come as soon as later this
month, when seasonal demand for cash will jump for the Spring
Festival, or Lunar New Year, but expect spikes to occur
regularly at the end of financial quarters.
Traders also warn that the resumption of initial public
offerings in China this month could put cyclical pressure on
short-term liquidity as subscriptions to new issues typically
temporarily lock up huge amounts of cash.
The PBOC has provided more detail on its concerns about the
mounting risk brewing in the shadow banking market in its latest
quarterly report published in November.
It said the proportion of money created by the interbank
market had exceeded capital inflows and securities investment
during some periods of 2013, becoming the second biggest
liquidity creator in the economy only after bank loans.
"The economy may have to experience a process of
de-leveraging and removal of overcapacity for a quite long
period," it said, marking the first time the word
"de-leveraging" has appeared in its high profile monetary policy
The interbank market in the world's second-largest economy
rarely attracted attention until the squeezes began in June, but
since then both domestic and global stock markets have proven
sensitive to signs of liquidity shocks in China.
The PBOC's 2013 China financial stability report published
in May revealed rapid growth in banks' interbank business.
Their interbank deposits reached 12.2 trillion yuan ($2
trillion) by the end of 2012, a 30.29 percent jump from a year
earlier, while interbank assets reached a high 15.13 percent of
their total assets, up 1.8 percent.
"The rapid increase in interbank business will to some
extent enable banks to bypass restrictions on loan quotas, go
around interest rate controls and cause distortions of
regulatory indicators," the stability report said.
"Some interbank funds are circulating inside the market
itself, weakening the ability of financial institutions to serve
the real economy."
The PBOC has steadily tried to tighten liquidity since 2010
in the face of persistent inflation, especially of food and
housing prices. That included 12 consecutive increases to banks'
reserve requirement ratios (RRR) over a period of less than two
years up to late 2011.
Consequently, banks' ability to handle seasonal demand has
been greatly weakened, traders say, with the RRR for major banks
now remaining at 20 percent of their total deposits, near a
record high of 21.5 percent.
In 2014, cash flows in China's interbank market will become
even more volatile as the U.S. Federal Reserve winds down its
quantitative easing (QE) policy over time.
"Still, the PBOC is likely to adopt a stance to only offer
limited cash in cases of acute shortfalls while sitting aside in
most cases to force banks to shift money back into core
operations," said a senior trader at a major Chinese state-owned
bank in Beijing.
($1 = 6.05 Chinese yuan)
(Editing by Jacqueline Wong)