In wake of cash crunch, PBOC commits to transparency but quietly tightens grip to become more controlling and secretive

In wake of cash crunch, PBOC commits to transparency but quietly tightens grip

Wed, Aug 7 2013

By Lu Jianxin and Pete Sweeney

SHANGHAI (Reuters) – China’s central bank has publicly committed to becoming a better communicator after a cash crunch that it engineered spooked global financial markets in June, but traders say its behavior has become more controlling and secretive. “There is a vicious cycle in China’s reform process,” said a senior trader at a Chinese state-owned bank in Beijing. “A deregulation move often creates a mess in the newly liberalized market. Then the consequent re-tightening suppresses the market again.”Global and domestic investors reeled in late June when the People’s Bank of China (PBOC) engineered a cash crunch in the short-term money market that saw rates spike as high as 30 percent for some tenors. The squeeze appeared to be a blunt warning to some banks to curb riskier lending practices.

The panic was short-lived as rates quickly fell back, but economists widely criticized the bank for failing to clearly communicate the reason for the move, which some misinterpreted as the onset of the long-feared liquidity crisis that would wreck the Chinese banking system and jeopardize the economy.

In response, the PBOC made two changes.

Publicly, it committed to improving its transparency in its latest quarterly monetary policy report published on Friday.

“The bank … will reinforce communications with the market and the public so as to stabilize expectations and guide the stable operation of interest rates,” the report said.

But in operational terms, traders say the bank’s commitment to “guide” the market has marked a return to the PBOC’s familiar babysitter role at the expense of reform.

BACK IN CHARGE

Even at the height of the squeeze, the bank was already showing signs of returning to its old opaque system of command-and-control.

For one thing, instead of visibly injecting cash through open-market operations to relieve the squeeze, the PBOC privately conducted numerous one-to-one transactions to rescue desperate individual banks, without disclosing how much was injected or to which bank.

This tactic had knock-on effects on sentiment in July because traders could only speculate when the funds injected in late June would mature and drain out again.

The central bank also quietly reissued a batch of three-year bills that had matured in July, which prevented 183 billion yuan ($29.89 billion) from re-entering the money market.

That move effectively halved the impact of the 342 billion yuan that was publicly injected into the market that month without anyone realizing it.

The PBOC also meddles on a daily basis, traders said.

A dealer at a Chinese commercial bank in Shanghai said that the central bank has begun to engineer quotations from major state-owned banks in order to keep rates in line.

“It appears the money markets now have quotations to guide short-term funding costs, similar to the way the central bank uses the midpoint in the foreign exchange market,” said the dealer, referring to the PBOC’s reliance on a daily fixed guidance rate to control the currency’s traded exchange rate.

“That means regulators have quietly set bottom lines for money market rates, a step backward compared with their commitment to give the market more say in financing rates.”

Because market dealers tend to pay more attention to the volume-weighted average price (VWAP) of money rates, a single, giant transaction between two big state-owned banks can effectively dictate the perceived rate for a given instrument regardless of wider market sentiment.

Traders told Reuters this happened routinely toward the end of July, when small banks and rural cooperatives grew increasingly desperate for cash, and yet VWAP rates stayed low. High quotations from smaller players, initially dismissed as wild outliers, may not have been as unusual as they looked, they said.

HITTING THE BRAKES

Most economists do not believe the PBOC has abandoned its goal of further liberalization, but as in so many other areas of the Chinese economy, it is stuck between a rock and a hard place.

On the one hand, the government is increasingly concerned that steadily slowing GDP growth will translate into unemployment and unrest.

On the other, distortions in the credit market need to be addressed, and the easiest place to do it is at the root of the money supply: the interbank market where banks borrow money from each other.

Beijing is moving to restrain the shadow banking industry, which has exploded since early 2011 thanks to the regulators tolerance of non-banking finance channels like trust loans and high-yield bonds to offset what was seen as an unhealthy overdependence on bank lending.

But the growth of the new markets, as measured by China’s homegrown Total Social Financing (TSF) tool, was clearly starting to run out of control in early 2013. TSF hit a record high of 2.54 trillion yuan in January and 2.55 trillion yuan in March, growing far faster than the wider economy.

Smaller banks were particularly enthusiastic, creating a host of high-yield wealth management products (WMPs) backed by assets ranging from high-yield bonds to inter-company loans to sales of ham.

Because such products frequently exhibited the sort of asset-maturity mismatch found in pyramid schemes, the small banks frequently tapped the interbank market at the end of each month to make sure they had enough cash to pay off investors on time, even though the assets behind the WMP had yet to mature.

By borrowing cheap money for a few days, the banks could both cash out customers and keep their books in order for monthly regulatory inspections.

Traders said the cash crunch was likely intended to punish this sort of behavior.

The new, tighter management regime, combined with administrative restrictions on shadow banking by the China Banking Regulatory Commission, appears to be taking effect: TSF growth has slowed sharply in recent months, down to 1.04 trillion yuan by the end of June.

But it is anyone’s guess how long it will take for the PBOC to trust commercial banks again.

“It takes time for regulators to find a good pace to push forward reforms,” said the senior trader in Beijing.

“And it takes time for market players to learn how to behave themselves.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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