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Resistance Remains Intact


(Z1) Still Climbing

     BEIJING (MNI) - Liquidity conditions in the banking system have been
surprisingly tight as 2018 nears its close, with the negative impact of new
financial regulations taking a toll on bank lending -- a result at odds with the
central bank's earlier assertion that financial institutions could "safely and
steadily" pass the year-end. 
     The resulting situation has left interbank traders in a tight spot. 
     "The liquidity conditions that the PBOC 'promised' weeks ago seem quite
different from what we've been through," an interbank trader at a commercial
bank based in Southern China said on Wednesday. "Today, the highest seven-day
repo and 14-day repo rate even reached 20% and 19.5%. You you can see how
expensive the money is getting and the difficult situation we are in."
     The benchmark seven-day and 14-day deposit repo (drepo) rates have
increased from 2.7649% and 4.3200% last Friday to 2.9769% and 5.2081% on
Thursday, the latter figure a three-year high.
     Financial institutions have suffered even more. The seven-day and 14-day
repo rates, reflecting the borrowing costs of all financial institutions, went
up from 3.0297% and 5.4362% last Friday to 6.9366% and 6.8035% on Thursday,
respectively -- their highest levels since 2014.
     Repo rates at stock exchanges have also increased rapidly, as more and more
financial institutions have turned to them to borrow money, given the freeze on
interbank market funding. The overnight exchange repo rate went up from 3.3552%
to 16.7901% on Thursday, the highest level since the end of September.
     The tight conditions in the banking system have largely been caused by the
PBOC's unwillingness to inject money into the banking system. As of Friday, the
PBOC has skipped open-market operations for six straight trading days, draining
a net CNY290 billion in the process. 
     The reason the PBOC gave for holding back on liquidity injections was that
it believed an elevated amount of fiscal spending at year-end was enough to keep
liquidity levels at a reasonable level, and would hedge the impact of maturing
reverse repos. 
     In reality, fiscal spending only started to alleviate liquidity conditions
marginally on Thursday, much later than many traders had expected.
     Another reason for the tightness was the impact of new regulations as well
the PBOC's month-end macro-prudential assessments (MPA) of banks, which have
affected banks' ability, and willingness, to lend money, according to traders.
     In the MPA tests, regulators will look to see whether banks are within
limits on credit growth, including on loans, bond investments, reverse repos for
non-bank financial institutions (NBFIs), interbank lending without collateral,
wealth management products that do not guarantee returns and non-standard asset
     As reverse repos are the least attractive type of asset -- their rates can
be very high, but their durations very short -- banks do not want to lend out
money via the repos to NBFIs as the MPA tests approach.
     In addition, new money market fund (MMF) rules that took effect on Oct. 1
only allow MMFs to lend out money to NBFIs that offer highly rated bonds as
collateral. However, many NBFIs do not hold highly rated bonds, preferring to
invest in lower-rated negotiable certificates of deposit (NCDs) and corporate
bonds in order to earn higher profits.
     A new rule covering commercial banks' liquidity conditions has also curbed
their enthusiasm for lending to NBFIs. Under the new rule, new liquidity
indicators, including liquidity matching ratios and net stable funding ratios,
will be affected if banks choose to lend out money to NBFIs. Although the rule,
announced earlier this month, has not officially taken effect, some banks have
already started to prepare for it. 
     Rates on NCDs have also continued to surge, which traders did not expect to
see happen. (See Nov. 24 "MNI China Money Week: Outlook Grim for NCDs as Bond
Rout Bites".) Primary rates on three-month NCDs issued by commercial banks went
up from 5.13% to 5.4% on Thursday, the highest since the end of 2014.
     On the demand side, new regulations have caused demand for NCDs to weaken.
     "In the past, it is either MMFs or banks themselves who are the biggest
investors in NCDs," Xu Hanfei and Li Yuze, analysts at China Merchant
Securities, said in a report on Tuesday. "MMFs often buy NCDs at quarter-ends
because the NCDs at that time often offer attractive yield levels. And banks
that have excess liquidity can buy NCDs, which is essentially a redistribution
of liquidity conditions in the banking system."
     "However, new MMF rules prohibit MMFs from investing in low-level NCDs, and
even investment in high-level NCDs is limited because there is a concentration
level requirement in the new rule. In addition, banks' holdings of NCDs will be
included in MPA tests next year," Xu and Li continued. "So weaker demand for
NCDs from both banks and MMFs have caused NCD yields to rise steadily."
     On the supply side, banks have also begun to make an effort to improve
their liquidity indicators.
     "I heard there are banks issuing NCDs and buying longer-term bonds,
including policy bank bonds and China government bonds," a Beijing-based trader
said. "Actually, all liquidity ratios can improve by issuing NCDs and buying
longer-term bonds, except for net stable funding ratios."
     But the money crunch might not last long, given the PBOC's promise of
fiscal spending landing in the banking system.
     "Right now is probably the toughest moment for liquidity conditions," Ming
Ming, an analyst at CITIC Securities, said in a report on Thursday. "As fiscal
spending is deposited into the banking system, the shortage of liquidity will be
alleviated. The targeted reserve requirement ratio (RRR) cut starting in January
2018 will help further resolve the structural problem of liquidity conditions."
     The targeted RRR cut will enable banks who meet certain criteria in
supporting the agricultural sector and micro- to small-sized companies to see
their RRRs lowered by 50 basis points or 100 basis points, depending on whether
they meet lower or higher criteria.
     In addition, on Friday the PBOC announced that it would set up a "temporary
required reserves usage arrangement" to allow commercial banks that suffer a
temporary liquidity crunch during the Chinese News Year season to temporarily
take out and use no more than two percentage points of their required reserves
parked in the PBOC for a period of 30 days, which should help alleviate any
liquidity shortages before the holiday as cash needs surge.
     But despite shorter-term liquidity needs being satisfied, some NBFI traders
are pessimistic about liquidity conditions for the coming year. 
     "For me, it is beyond doubt that the structural shortage of liquidity for
NBFIs will continue next year," a Shenzhen-based trader at an asset management
company said. "We can just gradually deleverage to make our liquidity better,
but deleveraging will be a very, very long process."
--MNI Beijing Bureau; +86 10 85325998; email:
--MNI Beijing Bureau; +86 (10) 8532-5998; email:
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