So....... it seems that China is moving to regulate and mop up dangerous levels of liquidity and hopefully help prevent the kinda hijinks that helped create the US finanicial crisis....... but in doing so, they might very well trigger said crisis as well as affect the whole world.China Gambles That A Credit Crunch Can Rein In Shadow Banking
The People’s Bank of China is treading on dangerous ground as it clamps down on their shadow banking system. As Chinese stock markets tank, and the contagion spreads, policymakers are looking to minimize regulatory arbitrage which has allowed small and medium banks to reduce capital requirements by nearly 75%, as the size the marginal banking system continues to grow. The move by China’s authorities is the right one, the real question is, will they be able to manage such a complex and leveraged system without screwing up.
“Discipline, not recklessness,” noted Ashmore’s Jan Dehn, speaking of the intense tightening in interbank lending markets sparked by Chinese regulators. Specifically, the PBoC decided not to inject extra liquidity into the market over the past few weeks, causing a mini-crunch that pushed the 7-day repo rate to a record 12% and the overnight repo rate to 25% last week. Nervous investors spooked by Bernanke’s taper talk pushed Chinese markets lower in the aftermath of those moves.
Pressure on interbank lending markets has eased, but rates remain very high, and markets continued to drop on Monday (the Shanghai Composite lost 5.3%). Yet Chinese authorities have reiterated their intention to keep monetary policy tight, with the PBoC issuing a note telling banks to “prudently manage liquidity risks that have resulted from rapid credit expansion.”
According to Dehn, small and medium banks used short-term financing through reverse repos with larger banks to reduce capital requirements by nearly 75% by bypassing risk ratings on corporate bonds. “Some banks have used interbank transactions with banks and nonbank financial institutions aggressively to fund their lending or offload their loans,” explained UBS ’ Tao Weng. Through regulatory arbitrage, and taking advantage of reverse repos and other forms of short-term financing, mid-sized banks (which get 23% of funding and capital from these markets, according to Moody’s) “increase leverage, hide loans, bad assets and risks,” Weng added.
In its statement, the PBoC said liquidity is adequate, a statement Dehn agrees with. In his research note, he explained Chinese banks have average excess reserves of 1.5% with respect to required ratios, which stand at 20% for large banks and 18% for smaller institutions. At the same time, broad money is growing faster than target, with M2 up 15.8% in May, and deposits are growing faster than loans. “We see no systemic risk,” the analyst said.
While the stock market suggests confidence in China’s policymakers is low, economists and analysts appear bullish. “The Chinese authorities have the power anytime they want to inject liquidity into the interbank market to end the recent stress,” explained Ashmore’s Dehn, in an opinion that’s echoed by several of his colleagues. At UBS, they believe new credit could fall, but that total social financing growth can be maintained at 17% to 18%, which should support nominal GDP growth of 10%. Others fear the tightening of credit has a good chance of seeping out into the general economy, with Nomura’s research team suggesting there’s 30% probability Chinese GDP growth slips below 7% in the second half of the year.
Risks remain. In the U.S., a liquidity crunch helped push Bear Sterns into insolvency, and it put intense pressure on larger institutions. The decision to let Lehman Brothers go under, though, sent the whole financial system into a freefall, prompting regulators to bail out AIG and inject capital in major institutions like Citigroup C -3.05% and Bank of America BAC -3.07%. “Accidents could happen in the process of changing liquidity provision or cleaning up interbank activities,” noted UBS’ Weng, who warned “this is especially so when much of the credit expansion so far has been hidden off balance sheet and often under multiple layers of transactions, liquidity is unevenly distributed, and interbank transactions have made the system highly linked
Stocks from as far away as Thailand, Australia and etc has already went downwards on fears of such news....... Anyone else who's more qualified in this care to comment?
