Preventing Vicious Circle of Default Requires Structural Policies

Xinhua: 防止信用违约走向恶性循环

The People's Bank of China announced recently that it has decided to appropriately expand the scope of medium-term loan facility (MLF) collateral. This is conducive to promoting the healthy development of the credit bond market, which is conducive to the restoration of the normal financing function of the credit bond market and breaking the vicious circle of “financing contraction—credit default”. The breach of contract is a normal phenomenon, but it should be avoided that disorderly breaches affect financial stability and the real economy. The introduction of structural policies is still expected.

RRR cut.

It should be said that breach of contract is a normal phenomenon in the mature credit bond market. Under the current tight financial supervision and de-levering situation, it is also an inevitable pain in the process of backlog risk release. Even if the number of recent breaches increases, the default rate of China's credit bond market is still low, and credit risk is generally low.

However, intensive breaches, especially unordered breaches, should be vigilant and need to be dealt with carefully. If letting a credit default go to a vicious circle, the existence of large-scale credit defaults, triggered liquidity risks, and even led to systemic financial risks may exist, which will have an impact on financial stability and economic growth.

Therefore, the regulatory authorities must take decisive action when necessary to cut off the vicious cycle. The new policy of the expansion of the MLF collateral introduced by the Central Bank may be one of them.

A key point overlooked in the MLF expansion that I pointed out:

Of course, after all, there is no inevitable link between the expansion of MLF collateral and the amount of funds put, and it is difficult to reverse the decline in market risk appetite. Whether bank institutions will actually increase the allocation of credit bonds is still uncertain. It can be expected that the regulatory authorities will be more balanced, de-leveraged and risk-preventive. In order to avoid “risk of disposal risks”, related supporting policies will be issued when necessary.

MLF collateral expansion and an RRR cut doesn't have an immediate impact in the market because as in developed countries, China operates a credit-money system that relies on credit creation by financial institutions. China had greater control over this system and can force banks to lend, but if it is not implementing a stimulus program, the banks are free to lend or not lend, and they will do so according to risk, reward and those are affected by sentiment.

Possible policies may not necessarily be total policies. In fact, the narrow sense of liquidity relaxation is not effective in relieving the credit risk caused by the tightening of broad credit. At least this year, the liquidity in the money market is not tense. Since the beginning of this year, relevant departments have issued a series of policies, all with structural features. Guiding capital flows to the weak areas of the national economy or specific areas that need support is a clear main line. Therefore, the introduction of more structural policies is worth the wait.

"More central planning."