After the Storm, Measure of Calm Returns to Interbank Market
(Beijing) – Liquidity in the interbank market this month has shown signs of improvement after the central bank intervened, but analysts agree that it is too soon to breathe a sigh of relief.
Liu Mingkang, former chairman of China Banking Regulatory Commission, said on July 27 at a forum held by Caixin that volatility is here to stay. The tightness is unlikely to ease before 2015, he said.
June saw one of the worst liquidity shortages in the country's financial history. Banks and other financial institutions struggled to get short-term funds from customers and each other, pushing up capital costs.
At first, the central bank did not react. Analysts said it was refraining from injecting capital into the market to pressure banks to deleverage.
Toward the end of July, the fear of another credit crunch became intense, and the central bank reacted by restarting reverse repurchase agreements on July 30. The last time it did so was on February 7. It took the step again on August 1 and August 6.
The scales of the three reverse repos were tiny compared with many of its previous reverse repos, which were taken in times of urgent liquidity shortages, but many investors believe that the worst is over.
The path ahead, however, remains challenging, Liu said. One primary concern is the impact of the huge capital outflows that will likely hit China as the U.S. Federal Reserve phases out its quantitative easing policy, he said.
"Liquidity has improved for the time being, but we cannot just sit there and wait for it to recover," he said. "We should learn the lessons and strengthen our liquidity management capability, including performing due diligence in reviewing the counterparties' liquidity conditions extra carefully."
Analysts are waiting to see what the central bank's next moves will be. One from Harvest Fund said his attention is focused on how the bank controls the yield of repurchase agreements.
There had been no substantive changes in the market that can ease the pressure of liquidity supply, Chen Long, an analyst at Bank of Dongguan, said. He expects capital costs to fluctuate narrowly around a relatively high level for the rest of the year.
Several sources from banks and securities firms said more institutional lenders are opting to deposit their funds in banks rather than lending to them through the interbank market because interest rates on interbank deposits can be significantly higher than those in the interbank lending market.
The central bank oversees transactions in the interbank market and it has the authority to censure financial institutions for setting their lending rates too high, a securities broker said.
The problem is no one knows for certain what the ceiling is under current circumstances, and most banks fear that the lending rates they want could break the limit, he said. In contrast, interbank deposits are regulated by China Banking Regulatory Commission and the interest rates can be determined with much more flexibility, he said.
The banking regulator has said it would pay more attention to banks' liquidity management in the wake of recent changes in the market.
Liu Yuhui, a research fellow of finance at the Chinese Academy of Social Sciences, said he doubts that banks started deleveraging after the June credit crunch. Instead, he said, they may have increased their exposure to real estate companies and local government financing platforms because few companies in other industries can afford a sharp increase in their capital costs.
Only when banks cannot pass on the cost of rising interest rates to property developers and financing platforms can they really deleverage and pay more attention to liquidity management, he said.
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