Short-term borrowing costs in China have climbed to their highest level in two years as comments from President Xi Jinping fan investor expectations that a “regulatory windstorm” is part of a broader crackdown on the financial sector.
China’s premier on Thursday described finance as the “core of a modern economy”, according to state news agency Xinhua, adding that “accurate judgment of potential financial risks serves as a precondition for maintaining financial security”.
On Friday the Shanghai interbank overnight rate, or Shibor, rose to 2.819 per cent — its highest level since April 3 2015, when the country was in the grip of a stock market bubble. The cost of borrowing money for three months was at 4.3 per cent, compared with a market rate of 2.8 per cent six months ago.
Since taking up his post in late February, Guo Shuqing, chair of the China Banking Regulatory Commission, has issued a stream of directives aimed at, among other issues, clamping down on shadow banking practices and raising lending standards in the interbank market.
At an internal government meeting on April 21, he pledged to “administer the strongest medicine” to address what he described as “chaos” in the banking system according to Caixin, a respected Chinese media company.
Applying a squeeze on interbank market liquidity by guiding short-term rates higher has become the strategy of choice for Chinese monetary authorities trying to rein in the country’s credit bubble without causing it to burst.
One of the main targets of the squeeze is a huge proliferation of “wealth management products” issued by banks but often kept off their balance sheets to elude capital regulations. These WMPs, the outstanding amount of which stands at Rmb29tn ($4.2tn) or equivalent to 40 per cent of GDP, are regarded as culprits behind the swelling of China’s unregulated shadow finance market in recent years.
The danger for China, though, is that by squeezing liquidity to curb WMP issuance, Beijing is also jeopardising a key funding source for some of the weakest institutions in the financial system, namely small and medium-sized banks. A scramble among such banks for liquidity has prompted a surge in issuance of bank certificates of deposit, increasingly at higher interest rates than such banks are receiving from their WMP investors.
“Regulators will have to tread very carefully to avoid creating too much of a shock to liquidity and credit creation,” said Chen Long, economist at Gavekal Dragonomics, the research group. “While maintaining financial stability and current economic growth rates are still the political bottom lines, regulatory action is now a risk for the domestic stock and bond markets.”
Chinese share prices have been sagging with the Shanghai Composite down more than 4 per cent over the past two weeks.
The interbank market liquidity squeeze has also spurred a record nine corporate bond defaults during the first quarter. Spectacular equity market ruptures, such as the 90 per cent crash one day last month in the share price of Hong Kong-listed China Huishan Dairy, have also resulted from a failure to honour debts in an environment of scarcer liquidity.
Analysts say persistently high rates in the interbank market, in spite of PBoC efforts to inject liquidity this month, reflect market caution around the likely impact of the reforms even as their existence is welcomed.