Interbank Spreads Widen in China, Regulators Threaten 3 Year Ban on Bad Actors

It's cash crunch time again with June 30 end of quarter approaching.

ZH: Meanwhile In China, Echoes Of Lehman As Interbank Market Freezes

In ominous echoes of what happened before, and certainly after the Lehman failure, it has gotten far harder for corporate bonds to be accepted as collateral for repo financing as lenders increasingly demand top quality bonds such as Chinese sovereign bills and policy bank notes as pledges, with Bloomberg noting that "traders are having second thoughts on taking even AAA rated short-term bank debt as security in the wake of last month’s seizure of Baoshang Bank"

As a result, funding among China’s financial institutions has become clogged, in some cases to the point of paralysis, which have already caused borrowing costs to spike for brokerages and smaller banks . The timing couldn’t be worse, not only due to China's slowing economy, but with liquidity traditionally far tighter at the quarter-end, and further adding to the wide-ranging ramifications of the bank seizure. All this could mean higher defaults, according to Bloomberg Economics.

“Non-bank financial institutions are actually the biggest buyers of corporate bonds in China, and if their funding chain breaks, demand for bonds, particularly those that can hardly be pledged for borrowing, will certainly get hurt," said David Qu at Bloomberg Economics in Hong Kong. “Weaker companies will suffer a rising cost when selling new bonds, which may eventually lead to higher default risks.”

This is gaining attention in Chinese financial media. 21st Century has an entire section dedicated to the topic.

21st Century: 非银信用保卫战
Sogou: Focus on the Safeguard of Non-bank Credit

21st Century: 同业存单结束下滑趋势：今日计划发行2389亿元，利率继续分化
Sogou: Interbank certificates of deposit end downward trend: 238.9 billion yuan is planned to be issued today, with interest rates continuing to diverge

"At present, 300 million yuan has been paid for one-month, three-month and one-year terms, with interest rates of 3.3%, 3.48% and 3.95% respectively. If you think the price is appropriate, you can announce the issue separately today." Traders of a city commercial bank in southwest China, which is issuing A-A certificates of deposit, told the inquirers that the bank had issued NCD one after another in early June. Each issue was subscribed for, "We have issued more than 2 billion out of a total of 4 billion."

Traders of a city firm in central China told reporters in 21st century business herald that the bank has plans to issue A-A certificates of deposit in the near future, and the market is fine.

Yesterday, information released by China Monetary Network showed that the interbank market actually issued 173 interbank certificates of deposit, totaling 93.83 billion yuan. According to estimates, the subscription rate was 78.26%, up from 77.8% last Friday.

Among them, the interest rate for AAA certificates of deposit in January was 2.8564%, and that for AAA certificates was 3.3328%, with a spread of 47.6 Bp, up 5.6 BP from last Friday's spread. The interest rate for the three-month AAA certificates of deposit is 2.9147%, the A-A certificate is 3.3921%, and the spread is 47.7 BP. The interest rate for one-year AAA certificates of deposit is 3.2684%, AAA is 3.8615%, and the spread is 62.4 BP. Both have expanded from last Friday.

Wu Di, an analyst at Huaxin Securities Research and Development Department, told reporters in 21st century business herald that the continued differentiation of inter-bank certificates of deposit grade spread is due to the decline in market risk appetite after the inter-bank certificates of deposit broke through the exchange and began to redefine low-grade inter-bank certificates of deposit. Although some easing policies have been made, there will definitely be a process of clearing market risks.

Regulators are threatening a 3-year ban on banks that do not honor repo pledges in the interbank market.

21st Century: 独家丨监管窗口指导敦促债券质押式回购履约，否则有可能停业务三年
Sogou: Supervision window guidance urges bond pledge repurchase to perform the contract, otherwise it may stop business for three years

On June 18, a number of bond traders confirmed to reporters in 21st century business herald that some institutions had received guidance from the regulatory authorities and would avoid default on pledge repo transactions starting today. If any organization goes against the wind, it may face the punishment of suspending relevant businesses for three years in the future. In order to prevent further aggravation of panic, the supervision requires institutions that have already defaulted on transactions or are at risk of default to do their utmost to ensure compliance. There are several ways for the market, one is to borrow money, the other is to sell bonds if it cannot borrow money or to offer substantial discounts for pledge financing. There is really no action to solve the problem with its own funds. If its own funds are insufficient, it can seek help from shareholders.

A senior manager of a securities firm's asset management company also said: "after the meeting last Sunday, the liquidity of the securities firm's proprietary business has eased somewhat, but the products are still the same. yesterday, there were some securities firms that defaulted on the repurchase of their products. There are also some who have used their own funds and received their own pledged bonds through a third party. "

At the same time, some market makers are also guided by the window, hoping to accept the pledge of some low-rated bonds, but with a certain discount rate. For example, the market reported that Citic Securities' proprietary trading began to pay out money today. The pledge criteria for accepting bonds are: AAA bonds accept 85% pledge, AA+ bonds accept 75% pledge, and AA bonds accept 65% pledge.

Zhang Xu, chief fixed income analyst of Everbright Securities, believes that in fact the People's Bank of China and the financial supervision department stand higher and look further, have more information than market participants and have a more comprehensive grasp of market dynamics. In contrast, the perspective of a single trading individual is relatively narrow, and it is easy to give a wrong perception of the market in a biased way and form unnecessary panic mood.

Reuters: China's small banks turn to exchanges for cash as money markets tighten

The volume of repurchase agreements on the Shanghai stock exchange, in which banks and other financial firms borrow money from each other using bonds as collateral, surged as borrowers sought an alternative to the over-the-counter interbank money market.

Traders said the lower borrowing costs on the exchange and the less stringent requirements for collateral drove smaller players to the exchange.

“Cost of borrowing on the exchange is lower,” said a trader at a Chinese bank in Shanghai.

The interbank markets were affected not just by shortages of cash but also concerns over the quality of the pledged collateral.

Traders said collateral requirements had tightened in the interbank market in the wake of regulators taking over the troubled and credit-laden Inner Mongolia-based Baoshang Bank.

Borrowers could still pledge their corporate bonds on the exchange for repos but lenders in the interbank markets had turned picky.

Bloomberg: China’s Lehman Moment Is Drawing Closer

That means counterparty risk and solvency risk have arrived – together.

With liquidity-related stress spreading and interbank confidence waning, financial regulators are asking large brokerages to take over the role of providing financing to small and medium-size enterprises from lower-tier banks, the financial news website Caixin reported Tuesday. Big brokers have a better understanding of credit risk than obscure provincial banks in any case, the thinking goes. Securities companies have been asked to issue financial bonds eligible for use as collateral, increase quotas for short-term debt, and ease funding pressures for nonbank financial institutions.

The decision to turn to brokerages is stunning. For a start, brokers aren’t banks; they don’t have the ability to take deposits and don’t create money, so their ability to expand liquidity is far more constrained. Secondly, regulators are relying on a securities industry that only four years ago oversaw a spectacular boom and bust in China’s stock market that was fueled by excessive over-the-counter margin financing.