MNI China Money Week: Long Wait On PBOC's 'Promised' Liquidity

     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.

     --STUBBORN PBOC

     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

investments. 

     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.

     --COMMERCIAL BANKS STYMIED

     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."

     --FISCAL SPENDING BOOST

     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: he.wei@marketnews.com

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

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