MNI SOURCES: PBOC To Boost Liquidity After Bank Takeover

     BEIJING (MNI) - The People's Bank of China is expected to further increase

its liquidity injections to prevent a jump in small banks' funding costs and a

possible liquidity crunch, amid rising concern over credit risk in the interbank

market after the central bank took over a troubled commercial lender, sources

told MNI.

     Since PBOC took over Inner-Mongolia-based Baoshang Bank May 24, citing

"severe credit risks", the central bank has tried to calm the market by

insisting that it was an isolated case and pumping in cash via its liquidity

tools and open market operations.

     "The central bank reacted very fast and effectively to smooth market

sentiment. Counter-cyclical policies will be strengthened as necessary and

policy flexibility will be further improved," a source familiar with the PBOC's

operations told MNI.

     In the week of May 27 following the takeover, the PBOC provided a net

CNY430 billion via its open-market operations, the largest weekly injection

since the middle of January. Its medium-term lending facilities lent out another

CNY500 billion last Thursday, the most this year. Another roughly CNY100 billion

in cash will also be unlocked on June 17, thanks to a previously-announced

targeted cut in reserve requirement ratios for rural commercial banks.

     Regulators are likely to further boost liquidity provision, and are closely

monitoring the possibility that investors could sell off or redeem the debt

products of small lenders, the source said. This would be devastating for the

banks, which are already struggling to place negotiable certificates of deposit.

     "There would appear to be a big liquidity risk if the situation turns

extreme," the source warned, adding that the authorities could if necessary

respond by making another targeted cut in reserve requirement ratios.

     Aggressive expansion by city and rural commercial banks has fed fears of

growing risks. Assets held by small- and medium-size banks rose 9.3 percentage

points over the past ten years, to 25.7% of China's total banking assets,

according to financial data provider Wind. Interbank loans to smaller banks

accounted for 30.4% of their total assets as of the end of 2018, Wind data

shows.

     A government advisor, asking to remain anonymous, said the Baoshang case

would prompt small banks to more quickly reduce the size of their balance

sheets, adding that leverage to fund speculation would become both more

difficult and less profitable.

     "This is the trend that regulators would like to see in the process of

deleveraging and preventing risks, but we must control the pace, or it could

turn very risky," the advisor said.

     For Baoshang Bank products individually worth over CNY50 million, only

about 90% of their principal will be repaid, the PBOC has said. These products

are largely comprised of negotiable certificates of deposit. It will be the

first time creditors have been forced to take losses on Chinese interbank NCDs.

     Chinese investors had up until now believed that all bank debt carried an

implicit government guarantee, a trader at a commercial bank told MNI.

     "The authorities have not allowed banks to go bankrupt over the past 20

years, so we did not really consider the counterparty credit risk in interbank

transactions. But now this faith is broken."

     Such market beliefs may help explain why Baoshang Bank managed to keep

rolling over CNY60 billion in NCDs despite failing to disclose its annual report

for two years and negative news about its biggest shareholder, Tomorrow Group.

     "We have been asked to scrutinize all transactions related to the bank and

started to be cautious towards small banks with high nonperforming loan ratios,

or which are issuing a lot of NCDs at a rapid pace," the trader said, "the whole

interbank market has felt the chill."

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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