China Shadow Banks Hit by Record Premium for One-Week Cash

(Bloomberg) -- This week’s squeeze in Chinese money markets is proving especially painful for the country’s shadow banks.

While interbank borrowing rates have climbed across the board, the surge has been unusually steep for non-bank institutions, including securities companies and investment firms. They’re now paying what amounts to a record premium for short-term funds relative to large Chinese banks, according to data compiled by Bloomberg.

The premium is reflected in the gap between China’s seven-day repurchase rate fixing and the weighted average rate, which widened to as much as 2.47 percentage points on Wednesday after some small lenders were said to miss payments in the interbank market. Non-bank borrowers tend to have a greater influence on the fixing, while large banks have more sway over the weighted average.

"It’s more expensive and difficult for non-bank financial institutions to get funding in the market," said Becky Liu, Hong Kong-based head of China macro strategy at Standard Chartered Plc. “Bigger lenders who have access to regulatory funding are not lending much of the money out.”

Without access to deposits or central bank liquidity facilities, many of China’s non-bank institutions must rely on volatile money markets. The People’s Bank of China has been guiding those rates higher in recent months to encourage a reduction of leverage, while also stepping in at times to prevent a liquidity crunch. The PBOC responded to this week’s jump in borrowing costs by making an unscheduled injection of hundreds of billions of yuan on Tuesday, and it followed that with another addition of cash through daily open-market operations on Wednesday.

Balancing Act

Non-bank borrowers will probably sell their bond holdings and reduce leverage, which is what policy makers want to see, Liu said. The knock-on effects could include higher company borrowing costs and more pressure on wealth-management products, which are major buyers of corporate debt, she said. The yield on ChinaBond’s index of three-year AAA rated corporate bonds rose 3 basis points to 4.39 percent Tuesday, the highest since Dec. 20.

The tightness in money markets can be explained partly by technical factors, including cash hoarding by banks before quarter-end regulatory checks. Money markets may face even greater stress at the end of June, when quarter-end checks coincide with another possible U.S. rate increase, said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore.

The seven-day repurchase rate fixing fell 50 basis points to 5 percent on Wednesday after the PBOC’s injections, while the weighted average declined 16 basis points to 2.93 percent as of 5:10 p.m. in Shanghai.

The institutions that missed payments on Monday included rural commercial banks, according to three traders who asked not to be identified. One said a borrower failed to repay an overnight repo of less than 50 million yuan ($7.3 million). The PBOC’s injections Tuesday occurred separately from the central bank’s daily open-market operations, through which the monetary authority has added 110 billion yuan so far this week. It had drained funds for 16 consecutive days through March 16, when it also increased interest rates in the operations for the second time this year.

"The PBOC is allowing smaller lenders to miss payments in order to force financial institutions to de-leverage," said Harrison Hu, chief greater China economist at Royal Bank of Scotland Group Plc in Singapore. "But it will keep a fine balance. It doesn’t want the pressures to become out of control. There’s a possibility that the PBOC will directly inject funds in smaller banks, if the cash shortage continues.”

--With assistance from Justina Lee

To contact Bloomberg News staff for this story: Tian Chen in Beijing at tchen259@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Michael Patterson, Robin Ganguly

With assistance from Tian Chen