Shibor, shibor everywhere and not a drop of cash to spare.
Bank of America Merrill Lynch rate strategist Bin Gao has a short note out on Tuesday entitled “A possible funding crisis in China?”
Here’s his exhibit A:
Which should be familiar to FT Alphaville readers. (Who will no doubt also point out how the Shibor is a problematic indicator and one is better off looking at the seven-day repo rate.)
As the graph above shows, the Shibor, or Shanghai interbank offered rate, spiked at the two calendar-semi-year ends.
But Gao argues that we should be more worried about the trend — and how it no longer mirrors the Libor/OIS spread — than the peaks.
The good news is that little is truly needed in three-month funding… China’s banks are primarily deposit funded with a regulated loan-to-deposit ratio of less than 75%. In terms of funding the liquid operations, repo dominates the Shiborbased interbank borrowing by a ratio of 2.5 to 1. Among maturities, the operation heavily gears toward overnight, which accounts for 74% of repo and 80% of Shibor volume. Since the funding transaction for any term longer than two weeks accounts for only 2-3% of the total transaction volume, the persistent nature of the 3M Shibor/PBoC Bill spread seems to be of little importance.
…however, the shortage for cash is real, all over the space. On the aggregate level, the deposit growth has slowed down significantly. As the growth rate comes down, the monthly deposit change has become much more volatile, projecting another level of uncertainty to banks as they fight over deposits. So far this year, there have been two months with deposit drops, which has never happened since 1998 (Chart 1). The growth rate was lower in 2007/08, but the funding spread then, though widened, behaved much more reasonable in the sense that they were both of lower magnitude and more stable (Chart of the Day).
There’s a scramble for deposits in China, as the central bank tries to rein in inflation while not causing disaster in the state-owned enterprises and local governments, which benefited from stimulus-era easy credit.
It’s hard to get a sense of the situation through Shibor alone, so Gao looks at another indicator, which we hadn’t seen used before:
Banks fight for deposits… Since the deposit base determines the loan book at a fixed loan-to-deposit ratio, we see banks’ competition for deposits remains intensive. We think there is no better indicator than the two-day deposit rates some smaller banks paid in June. It was reported that some banks in Wenzhou offered rates as high as 60-80bp per day for 30 June and 1 July, even though paying higher than the PBoC-published rates is against the rule.
Gao also notes that cash is tight on the corporate side (“account receivables increased by 30% from the same period last year”), especially among firms that receive payments from the Ministry of Railways, which was suffering from a cash shortage even before July’s high speed train crash.
What should the PBoC do about all this?
Increase rates. Confused? Gao explains:
A more desirable course for the PBoC is to raise rates. The correct combination of tools, in our view, is to increase interest rates to bring money back into the banking system while simultaneously easing liquidity. Higher interest rates potentially attract more cross border flows and increase the cost for the PBoC to manage higher FX reserves. But such issue can be dealt with by changing sterilization tools from PBoC bill issuance to RRR (Asset = Liability, Liquid Insight, 23 August 2011). In terms of liquidity injection, already, the PBoC reopened the 7d repo operation, which they haven’t employed since January this year. Such move has narrowed the short term funding spread in overnight Shibor and repo. In a sense, this operation is a rate hike for banks (charging banks repo rate at 2.7% while paying them interest rates on reserves at 1.62%) benefiting the central bank but not the depositors. What we suggest is needed is for the PBoC, or shall we say the State Department, is to formalize the practice in its inflation fight. We expect such a move, if implemented, will initially drove down the funding spread more than the rate increase, and hence favors a curve steepening position. If, on the other hand, the government continues to wage battle on inflation with quantity tools out of the concern of costs to SOEs, that may make us more concerned about rising systemic risk which we think can be better hedged with a deep OTM AUD rates receiver or a put on AUD the currency.
(H/T: Tracy Alloway)
Related links:
Just another Chinese cash crunch – FT Alphaville
What the China risk is – FT Alphaville