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Interbank Certificates of Deposit Thrive Despite Central Bank’s Disapproval

By Han Yi, Wu Hongyuran and Wang Yuqian

(Beijing) – Banks in China have continued to borrow heavily from each other using a popular but risky interbank lending tool, defying the central bank’s clear disapproval and a likely regulatory clampdown ahead.

In the first two weeks of March, the issuance of interbank negotiable certificates of deposit (CDs) exceeded 1 trillion yuan ($145 billion), following a record net increase of almost the same amount in February, according to data from Wind Information, a financial data provider. The issuance of CDs in January and February was 990 billion yuan and 1.97 trillion yuan respectively.

The interest rates that banks needed to offer to get funds through the CDs have increased as well, reaching an average of nearly 4.77% on March 22 for a three-month contract. In late August, when the central bank started raising money costs through open market operations by tightening the supply of short-term, cheaper funds, the rate was only about 2.8%.

The current interest rates on many CDs are 30 to 50 basis points higher than short-term commercial papers issued by enterprises. This is not normal because lending to a bank is safer than lending to an enterprise, said a bond investment manager at a securities fund company.

The surge in CD issuance and rising interest rates that reflect strong demand comes despite prevailing anticipation that the central bank will take some measures — although opinions diverge as to when and how — to rein in the business due to concerns about financial risk.

Each interbank CD allows a bank to take a deposit of 50 million yuan or more at a negotiated interest rate from another bank or another financial institution that can participate in the interbank market. The certificate could be sold but is usually not redeemable before it matures, meaning the bank receiving the deposit can invest the fund without having to worry about early withdrawals.

Interbank CDs were introduced to China in late 2013 as the central bank sought to liberalize interest rate controls.

The issuance of CDs picked up pace in mid-2015 and continued to rise at even faster rates through March. The growth was driven largely by the fact that funds received in the form of CDs are treated differently from other types of interbank loans, which are subject to a regulatory limit equal to one-third of a bank’s total debt.

Small and midsize banks have been the primary issuers of interbank CDs. According to a research report from Haitong Securities, nearly 90% of the 7.4 trillion yuan worth of outstanding CDs as of March were issued by the national joint-stock banks and city commercial banks.

The surge came along with increasing interbank investment in wealth management plans, indicating that banks were using the deposits from CDs to buy other banks’ wealth management plans rather than making loans to support nonfinancial enterprises and individuals.

More than 15% of bank wealth management products were held by other banks as of June 2016, up from less than 4% at the beginning of 2015, an increase of 3.5 trillion yuan over a period of just 18 months, according to Haitong’s research.

A bond market rout that was blamed largely on such interbank lending and investment has triggered regulatory reaction.

Sources close to the central bank said the regulator had started requiring banks to report their interbank CDs under the category of interbank loans, an important factor in the national Macro Prudential Assessment (MPA) framework, a comprehensive financial-risk monitoring and mitigation system that was implemented last year.

The change has remained for monitoring purposes at the moment, according to the sources. It’s unclear when or whether the central bank will revise its obligatory requirements accordingly to make the MPA limit on interbank lending apply to all loans, including those through CDs.

A clear-cut application to all interbank CDs may shock the market because some banks have grown too reliant on the funding tool to give it up immediately without triggering contagious risks, some bankers said.

“There were times that many joint-stock banks’ interbank CDs alone exceeded the one-third limit on interbank loans. Some were even higher than one-half,” said a manager at a large state-owned bank.

“If CDs were to be included immediately into interbank loans, these banks would all violate the regulation,” he said. “As it stands currently, the banking industry has already become too dependent on interbank loans. If any strict restrictions are implemented roughly, the market would be bound for great turmoil.”

Banks issue interbank CDs within a quota approved by the central bank. As of Feb. 22, a total of 375 banks have announced their approved CD plans this year, which added up to 14.39 trillion yuan, an increase of 1.14 trillion yuan from the combined quota approved for all of 2016, according to research by Citic Securities.

Banks rushed to apply for CD quotas not only because they need funds now, according to analysts from China International Capital Corp., an investment bank. Many were also apparently trying to catch a ride on the last train, as they expect the central bank to get much tougher on CD issuance.

A lot of new CDs must be issued just so banks can keep the deposits they obtained previously through old CDs that are maturing, a manager at a national joint-stock bank said. In February, for example, more than 1 trillion yuan worth of interbank CDs matured, and the figure for March is 1.59 trillion yuan.

Issuing new CDs to replace old ones at growing interest rates is a recipe for disaster when the bond market no longer provides a return high enough to cover the financing cost, said Ming Ming, a bond analyst at Citic Securities. The current interest rates carried by many interbank CDs have exceeded those offered by same-maturity bank wealth management plans. Under this situation, if a bank were to need to keep selling new CDs to repay old ones, it would easily be caught up in a vicious circle, he said.

Some experts have suggested the central bank take it slowly to implement necessary corrections to interbank lending so as to avoid shocking the market.

Zeng Gang, research chief of banking finance at the Chinese Academy of Social Sciences, said the central bank can make different rules for interbank CDs based on how much time they have until maturity.

“The key to regulation is differentiating the type of debts according to the funds’ nature and stability,” he said.

Zeng suggested the central bank treat interbank CDs with a minimum residual time to maturity as the borrowing bank’s “core debt,” an indicator closely monitored and regulated by the China Banking Regulatory Commission (CBRC).

The CBRC has in fact released this year a new template for banks to follow when reporting their liquidity conditions, which added interbank CDs with at least 90 days until maturity to tools a bank can use to borrow its most important, medium- to long-term “core debt.” A bank’s core debt must stay above 60% of its total debt, according to the banking regulator.

Critics have worried if the CBRC rules may actually encourage banks to issue CDs, contrary to the central bank’s intention.

The central bank clearly wants to rein in interbank CDs by including them into its MPA framework. “This is consistent with its broad effort to have financial institutions deleverage,” a source close to the regulator said.

Right now, the expanded scope of monitoring has served as reference only. “If the central bank presses ahead to enforce the change, it means it has weighed and decided to accept the risk the implementation may cause to the market,” the source said.

Contact reporter Wang Yuqian (yuqianwang@caixin.com)

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