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REPEAT: MNI China Money Week: Party Mood as PBOC Loosens

Repeats Story Initially Transmitted at 08:02 GMT Jul 28/04:02 EST Jul 28
--Financial Institutions, Particularly Small Banks, Releveraging While They Can
     BEIJING (MNI) - Chinese financial institutions are quick to spot an
opportunity and rarely let one pass. They wasted no time taking advantage of the
central bank's relaxation of liquidity conditions in June to ease market jitters
about a seasonal cash crunch, and another temporary loosening in mid July. As
cash was pumped into the interbank bond market and interest rates started to
edge down, they jumped back onto the leverage dance floor. 
     The tell-tale signs were everywhere - notably a jump in issuance of
Negotiable Certificates of Deposit (NCD) by banks in the interbank market, and a
surge in loans from deposit-taking banks to non-bank financial institutions,
which were mostly channelled into purchases of asset management products.
     Although Chinese regulators have continued to pursue their campaign to
deleverage the financial sector, they've also sought to strike a balance between
curbing the worst excesses and "maintaining stability" in the financial markets
to avoid any potential for volatility that could spin out of control. Many
financial institutions have been betting on the shifting sands of this balancing
act, leveraging up when stability is in the ascendant and liquidity rises to
engage in the profitable arbitrage opportunities this throws up. 
     "We had to seize the day," a trader from a city commercial bank on China's
east coast told Market News. "We couldn't pass up this opportunity when market
interest rates were comparatively low. We were seriously limited in April and
May when the regulatory environment was so tough."
     Although the Chinese leadership has set its sights firmly on curbing the
growth of leverage in the financial sector and pushing banks to lend to the
so-called "real economy", it recognizes this cannot be done overnight. The
People's Daily, the mouthpiece of the ruling Communist Party, noted earlier this
month in a commentary on financial regulation that deleveraging can not be
accomplished in one stroke because the financial sector has a natural tendency
to add leverage. Although the authorities need to prevent systemic risks, they
have to guide money away from the financial sector and into the real economy at
a controlled pace, it said.
     The PBOC was unexpectedly generous to the interbank market last month, with
traders describing a market in carnival mood as it feasted on the central bank's
liquidity injections. The PBOC pumped roughly CNY620 billion into the market
from June 1 to June 19 through open-market operations and its Medium-term
Lending Facility. Although the PBOC drained that amount and more from late June
until early July, it turned the taps on again from July 11, adding CNY510
billion last week alone via OMO, the largest weekly net injection since mid
January. 
     Regulators eased up on some of the deadlines and controls they had
previously imposed on banks and financial institutions, and the end-June
hoarding of cash to meet the central bank's Macro-Prudential Assessment also
passed, which helped pump up the party atmosphere. 
     The average rate on the benchmark seven-day repo, which reflects the cost
of borrowing among banks in the interbank market, fell by almost 90 basis points
over the course of June, closing at 2.5% on June 30 compared with 3.44% on May
31. The rate on Friday was still relatively low and last at 2.8057%. 
     "As money-market rates went down and liquidity was good, a lot of
institutions started to borrow money to buy higher yielding bonds," said a
trader with a state-owned bank in Guangdong province. "City commercial banks and
smaller banks especially were doing this."
     Another trader with a bank in northeast China said his bank had added
leverage to try and scrape back lost profits. "We've been under a fair bit of
pressure. With money-market rates down, if we didn't take this chance it would
be really hard for us to pay out the high yields we've promised on our wealth
management products. A lot of smaller banks have to rely on making money off the
thin margins they make on interest-rate spreads." 
     Banks' net issuance of NCDs, which generates interbank liability, surged to
CNY373.9 billion in June after showing negative growth of CNY333.3 billion in
May and an increase of only CNY115.7 billion in April. Net issuance of NCDs this
month as of July 26 has been similar to June's figure at CNY352.4 billion,
according to Wind Information, a Shanghai-based financial data provider.
     The outstanding amount of NCDs issued by city and commercial banks rose by
CNY200 billion in June to CNY3.83 trillion, while that of joint-stock banks was
CNY3.56 trillion, unchanged from May, according to data from Tianfeng
Securities, indicating that it's been small and medium-sized lenders who have
been the most aggressive in taking on more debt to buy products with higher
yields. 
     Non-bank financial institutions (NBFI), including funds and securities
companies, have also been leveraging up. Banks' claims on other financial
institutions, which includes loans to NBFI, purchases of asset management
products from NBFI, and trust and entrusted investments, rose by CNY1.4 trillion
in June to CNY28.5 trillion, the biggest monthly increase in value terms since
January 2016 and snapping a two-month decline. 
     Another indicator of leverage in the interbank market, the outstanding
amount of bonds used as collateral in repo agreements, rose to a record CNY5.26
trillion at the end of June, up CNY770 billion from May, after the amount
declined over CNY990 in April, according to Wind.
     The value of bonds deposited at the China Central Depository & Clearing
system rose to CNY46.43 trillion in June from CNY45.68 trillion in May,
according to data from the China Central Depository & Clearing Co. Data for July
is not available yet. 
     "The increase in bonds pledged as collateral and at the depositary
indicates that the leverage ratio in the bond market is rising due to the
recovery of the bond market in June and the sluggish issuance of bonds in the
primary market," Ji Linghao, a bond analyst with Huachuang Securities told MNI.
     The question now is how long the carnival will last. With the PBOC firmly
in control of the party, the market is searching for clues as to whether it will
turn the volume down or switch the music off altogether.
     The National Financial Work Conference (NFWC), where top policy makers map
out financial reform and regulation, met in mid July and the PBOC held a
follow-on meeting this week, where it stressed the need to continue to implement
a "prudent and neutral monetary policy" and maintain "basically stable
liquidity" in order to create the appropriate monetary environment for President
Xi Jinping's supply-side reforms. The message received by the market is that
liquidity won't be loosened much but it won't be tightened too much either. 
     "From the stance the authorities have shown in several important meetings
recently, the PBOC may not further tighten regulations for the financial sector
since it will focus more on maintaining stability and preventing risks, so the
current 'neither tight nor loose' situation will continue," said the trader in
eastern China. 
     Others say the PBOC's liquidity injections are just a short term
phenomenon, given the focus of the NFWC on curbing financial risks and
deleveraging. There's also uncertainty over how tough financial regulation may
get in the wake of the establishment of the Financial Stability and Development
Committee to oversee regulation. 
     "The authorities' determination to deleverage has not changed, so the theme
will still be tightening, " Huachuang Securities' Ji said. "The recent
releveraging is obviously going in the opposite direction to what regulators
want, so these financial institutions who have leveraged up again need to be
careful." 
     The PBOC's generosity continued this week, with a net injection of CNY141.5
billion via its open market operations. On the monthly basis, the net OMO
injection by July 28 reached CNY232.5 billion in July, much more than the
CNY106.7 billion in June and CNY69.5 billion in May, indicating the central bank
is not tightening liquidity. 
     "Although the PBOC left the liquidity injection unchanged in Tuesday and
Wednesday, the liquidity situation is not very tight. Seven-day capital is in
short supply, since institutions are preparing for cross over to the next
month," a Beijing trader in a join-stock bank told MNI. "The liquidity situation
will remain at a neither tight nor loose level, as the PBOC's intention will be
just to hedge the maturity of reverse repos," he said. 
     The average rate on the benchmark seven-day repo - which is in effect the
drepo, the cost for banks, rather than all financial institutions, to borrow
from each other in the interbank market - was last at 2.8057 Friday afternoon
from a closing rate of 2.9099 the previous Friday.
     The yuan exchange rate continued to strengthen, guided higher by the PBOC,
as the U.S dollar index fell. The yuan appreciated by around 0.3% against the
greenback this week, the third consecutive weekly gain, and was last trading at
6.7487 per dollar. For the month so far, the Chinese currency has strengthened
by 0.46%, the fourth month of appreciation in a row. 
--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com
--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com
--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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