MNI China Money Week: Liquidity Noose Tightens Around NBFIs

--PBOC Takes Firm Stance On Loose Cash Ahead Of Holiday

--Drepo Rates Remain Elevated

     BEIJING (MNI) - Liquidity conditions were unexpectedly tight in China this

week, especially for non-bank financial institutions (NBFIs), due to the

unwillingness of the People's Bank of China (PBOC) to inject money via

open-market operations and also because of new money market funds rules that

take effect on Oct. 1.

     The market had expected liquidity conditions to be quite loose or at least

stable this week on increased demand for cash ahead of the week-long National

Day holiday next week and as banks faced quarter-end regulation tests including

the PBOC's Macro Prudential Assessments (MPAs). The PBOC was also expected to

maintain equilibrium ahead of the Communist Party's 19th National Congress that

starts on Oct. 18.

     In addition, faster fiscal expenditures at month-end/quarter-end were also

expected to help boost liquidity, as government money moves from the PBOC's

account to the banking system.

     However, the 14-day and 21-day deposit repo (drepo) rates for bank

borrowing, which are more representative of liquidity conditions than the

seven-day reverse repo rate because no trading will occur during next week's

holiday, remained high, averaging 3.984% and 5.024% this week, respectively,

compared with 4.163% and 4.737% last week. The 14-day and 21-day reverse repo

rates, reflecting the borrowing costs of all financial institutions, increased

to 4.796% and 5.743% this week, compared with 4.276% and 4.913% last week.

     Difficulties in borrowing money combined with the expensive price tag for

doing so prompted one trader to declare that this was "the most torturous last

week of September ever."

     "The lending rate for 14-day money reached 11% during the day, and big

banks were not willing to lend money to satisfy borrowers' needs," an interbank

trader for a commercial bank based in central China said on Wednesday. "Previous

expectations were too optimistic," he said. "Some financial institutions had

high leverage, so the funding gap for them was big."

     A Beijing-based bond trader with a commercial bank said the 14-day reverse

repo rate was around 9% all day long on Wednesday. While the funding price went

down on Thursday, it remained relatively high. 

     The experience this week has the market worried that tight liquidity

conditions will carry over into October. 

     The PBOC drained a total of CNY360 billion via open-market operations this

week, adding to the feeling that the easier liquidity conditions seen the past

few weeks were a fleeting phenomenon.  

     "Now many financial institutions are preparing to borrow money in advance,"

the interbank trader in central China said. "In the past, for financial

institutions who borrow money to meet quarter-end test standards, the shorter

the term of money [they could borrow], the better. So if seven-day money is

available, they will definitely not borrow 14-day money. If 14-day money is

available, they will surely not borrow 21-day money. But many financial

institutions have borrowed 21-day money in recent weeks, showing that they are

worried about liquidity conditions in October."

     The PBOC has not shown any signs that it will loosen its stance.

     "The continued tightening of liquidity conditions reflects the PBOC's firm

attitude to keep liquidity tight, yet balanced," Hua Chuang Securities said in a

note Tuesday. "The PBOC learned a lesson from the end of March and the end of

June, when liquidity became too abundant. So they kept liquidity conditions

tight [this week] on purpose to prevent financial institutions from leveraging

up again."

     The liquidity problem is in part structural, with NBFIs suffering more than

big banks, because big banks receive liquidity directly from the PBOC and can

then decide whether to lend it out or not.

     The CFETS-ICAP money market sentiment index clearly showed that the

sentiment of NBFIs was worse than that of big banks, with the average index of

the former at 61.2 this week, higher than the 56.9 of the latter. 

     The 14-day reverse repo rate on the Shenzhen Stock Exchange, measuring the

borrowing costs of NBFIs, jumped from 5.0553% last Friday to 6.7303% this

Wednesday, before falling back to 6.1682% on Thursday. 

     Apart from their already high leverage, new rules on money market funds are

also impacting NBFIs' ability to borrow money.

     The new rules, which take effect Oct. 1, prohibit money market funds from

accepting collateral with a rating lower than "AA+". However, most NBFIs have

invested significantly in lower-rated bonds that in the past the NBFIs could use

as collateral when borrowing from money market funds. This will no longer be the

case, meaning NBFIs will face more difficulty getting funding.  

     Money market funds are an important source of financing for NBFIs.

According to China International Capital Corporation's estimate, money market

funds provide about one-third of the daily funding to asset management products

and other types of funds, which are part of the NBFIs.

     "Money market funds serve as an intermediary between banks and NBFIs," CICC

said in a report on Wednesday. "The strategy of money market funds includes

borrowing overnight money from banks and then lending it out to NBFIs to earn

the spread. They are the main funding providers for NBFIs."

     "Even if increases in fiscal expenditures help to boost liquidity, the

money will follow a pattern of flowing from big banks to small and medium-size

banks and then to NBFIs," CICC said. "So the unwillingness for money market

funds to lend to NBFIs will make it more difficult for them to get money, so the

liquidity condition gap between big banks and NBFIs will likely increase."

     "On top of that, the impact of the new rule is not fully understood and

anticipated by NBFIs" CICC added.

     Some analysts, though, disagreed over future liquidity conditions. 

     "The State Council said on Wednesday that the required reserve ratio of

banks that met the requirements to support micro-companies will be lowered, so

that will be helpful to overall liquidity conditions," Shenwan Hongyuan

Securities said on Wednesday. "Also, as [new] regulatory policies are gradually

announced in the fourth quarter, there will be no need for the PBOC to force

financial institutions to deleverage by keeping the funding price at a high

level. So liquidity conditions will gradually improve."

     Other analysts were more cautious.

     "Maturing reverse repos and Medium-term Lending Facility instruments amount

to around CNY1.1 trillion in October. Given what we have seen in the past,

whether the PBOC rolls over [those amounts] is still uncertain, and so liquidity

conditions will very likely fluctuate," Hua Chuang Securities said on Monday.

"In addition, October often features substantial fiscal deposits, which will

transfer money from the banking system back to the PBOC and drain liquidity from

the banking system." 

     "So it is very difficult to say that liquidity conditions will be good in

October," it concluded.

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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