Tight Interbank Liquidity Tests China's DelicateDance Between Bank Discipline And Stability
China's interbank liquidity appears to have dried up abruptly. The weighted average of the overnight borrowing rateamong the country's banks soared to 13.8% on June 20, a jump of 610 basis points (bps) from a day earlier or 1,050 bps from a month ago. The rate eased to 9.0% on June 21 but still remains high. Standard & Poor's Ratings Services believes that the spike in costs mainly stems from the central bank's policy stance of curbing some Chinese banks'excessive expansion through wealth management business, and the associated dependence on interbank borrowing forliquidity. Indeed, the People's Bank of China (PBOC) has not intervened to alleviate interbank borrowing rate pressure,as it has done in the past.Despite the short-term volatility in liquidity, the Chinese economy and banking sector continue to have excessiveliquidity. The rapid rise in interbank borrowing rates is likely to be temporary as China's banks will gradually adapt tothe new setting by adjusting their asset portfolios. Furthermore, we believe the PBOC will find a balance betweendisciplining interbank activities and safeguarding financial stability. But such a well-meaning approach, thoughmoderate, could have unintended consequences in the longer term on China's slowing economy, particularly on banks'asset quality and profitability.
We expect the recent liquidity tightness in China's interbank market to persist toward the end of June 2013,and gradually ease afterward, assuming the central bank continues to play a passive role.
In our view, the PBOC has avoided intervening in the interbank market because the central bank intends tocontain aggressive growth of WMPs as an alternative channel for banks to increase credit disbursal.
We don't expect the currently tight interbank liquidity to significantly undermine Chinese banks as we expectthe borrowing rate to gradually ease.
Tightening Liquidity May Curb Rampant Growth Of Wealth ManagementProducts
The PBOC has been the main actor missing from the action in recent weeks. It has not injected liquidity to alleviate thepressure on the overnight interbank borrowing rate, which has surprised markets considering its past interventionistapproach. This inaction, in our view, is the key reason behind the recent tight interbank liquidity.Nevertheless, a confluence of multiple factors has also played out to tighten market liquidity. These include: (1) slowercapital inflow because of the Chinese government's crackdown on hot money since early May 2013 and a possiblereversal in capital flow since the U.S. Federal Reserve's recent indication to taper off quantitative easing; (2) growingpressure for statutory reserve placement as a high proportion of banks' wealth management products (WMPs) had been structured to mature toward the end of June; (3) periodic transfer of temporary fiscal deposits from commercial banks to the central bank; and (4) rising precautionary liquidity holdings of the whole sector amid PBOC's inaction and
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