By Saikat Chatterjee
HONG KONG, June 27 The liquidity crunch in
China's financial system last week spooked global markets and
led to a downgrade in the outlook of Hong Kong banks that has
raised alarm bells about contagion.
The widespread panic from the dizzying spike in onshore
interbank rates offers a valuable lesson in risk management for
the gatekeepers of Hong Kong's growing yuan markets as the
territory's banks have deep ties to state-run mainland banks.
China's central bank has balked at injecting funds into the
money markets as it cracked down on funds flowing into the
country's vast informal loans market known as "shadow banking".
While offshore markets saw only moderate volatility from the
credit squeeze and plunging stock prices, the spillover effects
are hard to ignore even for the most ardent cheerleaders of
China's yuan internationalisation project.
"As the cross border channels strengthen between the onshore
and the offshore markets, it is not going to be easy for Hong
Kong's regulators to avert a contagion effect and they need to
be prepared to stem any impact," said Becky Liu, a strategist at
Standard Chartered Bank.
The shortage of funds in China has spilled over into Hong
Kong, pushing up the cost of funds in the growing offshore yuan
market amid speculation that subsidiaries of Chinese banks were
remitting money to the mainland.
The clearing bank for yuan-related transactions in Hong Kong
and Taiwan had to raise yuan interest rates this week to attract
more yuan deposits. Some Chinese banks reportedly jacked up
deposit rates for short-dated yuan funds, and the Chinese
government narrowly sold out a jumbo bond sale on Wednesday.
Indeed, Fitch Ratings said this week that sustained stress
in the Chinese interbank market would raise counterparty risks
for Hong Kong banks' exposure to mainland banks arising mainly
from interbank placements and from guarantees on trade finance.
Fear of a banking crisis are surfacing as the world's
second-largest economy is already showing signs of slowdown.
Confidence in Hong Kong's banking system is also critical at
a time when the yuan becomes more popularly used in business and
trade, making new inroads into markets outside Asia.
One way to prepare for any funding crisis is to let Hong
Kong banks have unlimited use of short-term yuan funds via a 400
billion yuan ($65.07 billion) swap line the Hong Kong Monetary
Authority (HKMA) has with the People's Bank of China.
While on paper, the swap line is in place to avoid any
short-term funding mismatches arising mainly due to trade, the
HKMA can soothe concerns by making it clear that banks in the
city can tap this funding channel to get emergency yuan funds.
It was precisely Beijing's refusal to release short-dated
funds to desperate Chinese lenders in the last couple of weeks
that exacerbated the crisis.
Moreover, Hong Kong would be reluctant to trigger any fresh
shortages after the previous two episodes in October 2010 and
September 2011. Offshore markets went into a tailspin after the
trade settlement quotas were exhausted in both instances, which
choked off the supply of offshore yuan and forced regulators to
undertake major damage control.
The HKMA can also shorten its settlement cycle for releasing
yuan funds to banks, which currently, takes place one day later.
The HKMA can pass on to banks the cost of swapping Hong Kong
dollars to yuan and procuring yuan at higher interest rates in
A secondary concern arising out of such a backstop funding
facility is that some banks may use this emergency access to
funds to channel money back into its cash-strapped branches
onshore via the growing channels of trade and commerce.
But that concern can be easily addressed by demanding
collateral in Chinese yuan or even Hong Kong dollar assets.
Analysts have also warned Hong Kong banks against exploiting
opportunities to expand lending to Chinese companies as their
mainland counterparts struggle for funds, as it could have an
adverse impact on their asset quality.
"Hong Kong banks have substantially increased their mainland
China exposures to 16.5 percent of consolidated total assets at
end-2012, up from 9.8 percent at end-2009," said Sonny Hsu, vice
president - senior analyst at the Financial Institutions Group
at Moodys' Investor Services.
WEEK IN REVIEW:
China's Ministry of Finance managed to sell $2.1 billion of
yuan-denominated bonds in choppy market conditions in Hong Kong
on Wednesday as fears of a credit crunch eased. There were two
interesting facets to this bond sale -- a 30-year tranche which
was a novelty to the offshore yuan bond market, being the
longest maturity to date. A tranche of the bond sale reserved
for only central banks attracted good demand. The 3 billion yuan
tranche received about 5.48 billion yuan of orders from about
eight central banks in Asia, Africa and South America.
The main clearing bank for yuan-related transactions in Hong
Kong and Taiwan raised interest rates this week in a bid to
offer more competitive rates to attract yuan deposits. Bank of
China raised the interest rate it will pay for other banks' yuan
deposits to 0.75-1.05 percent from a flat rate of 0.648 percent,
effective next month in Hong Kong.
In Taipei, Bank of China will raise overnight rates for yuan
deposits in July in a bid to lure more yuan funds from Hong
Kong, a source said. The hike in interest rates comes amid some
reports that some Chinese banks were offering higher interest
rates for short-dated yuan retail deposits and some companies
were shipping their excess yuan funds across the border.
Moody's Investors Service downgraded the outlook of the Hong
Kong banking system to negative from stable reflecting its
concerns over persistent negative real interest rates and banks'
growing exposures to mainland China.
In response, the city's de-facto central bank struck a
confident stance with a spokeswoman at the Hong Kong Monetary
Authority noting the ratings agency continued to recognise the
Hong Kong banking system's strong financial metrics and high
credit ratings relative to global peers. "We will continue our
close dialogue with Moody's to ensure that the agency maintains
a balanced view on the Hong Kong banking system's outlook," she
CHART OF THE WEEK:
China credit default swaps:As a near three-week cash squeeze in the mainland gripped
the attention of global markets, the market for credit default
swaps on Chinese assets became the microcosm for monitoring the
ebb and flow of market jitters. Credit derivatives of the
Chinese government and Bank of China particularly were actively
traded with spreads on these swaps spiking sharply higher in
Taiwan must liberalise to make most of offshore renminbi-study
Clearing bank raises offshore yuan interest rates as cash
CNH Tracker-Onshore fund squeeze could rattle "dim sum" bond
cartMore stories about the CNH market
Daily onshore yuan reports
Daily China money market reports
Offshore yuan rate Onshore yuan rate
Offshore yuan dealt Onshore yuan on CFETS
THOMSON REUTERS SPEED GUIDES