China is enjoying a little funding squeeze

Via Bloomie:

China’s central bank has acknowledged its monetary tools are insufficient. The most powerful ones are proving too blunt to drill through a hardening financial system.

The country’s money markets have been shuddering since regulators took over Baoshang Bank Co. last month, despite initial assurances from the central bank and other authorities that they would maintain ample liquidity. While there has been little direct contagion, the seizure of the small commercial lender has hurt confidence. Funding costs for companies have shot up as large banks flinch from lending to some counterparties in the interbank market. For the first time in more than two decades, lenders face the prospect of defaults and haircuts on loans to other financial institutions, according to the Rhodium Group.

Counterparty risk is the worst kind. It can’t be resolved with liquidity because it is a simple distrust in solvency. More from Bloomie:

It’s now getting 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. 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 Co.

That’s clogging up funding among China’s financial institutions, which have already caused borrowing costs to spike for brokerages and smaller banks. The timing couldn’t be worse with liquidity generally tight at the quarter-end, and further adds 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.”

There is daisy chain of interbank lending from large banks to medium banks to brokerages that buy corporate bonds, hence the rising funding costs across the spectrum.

Regulators are moving to head off the issue, via Caixin:

Chinese regulators called on the largest state-owned banks to provide financing to the country’s leading brokerages as part of efforts to calm market jitters caused by the government takeover of a private bank last month.

A meeting Tuesday involving the central bank, securities regulators and top banks and brokerages continued a series of steps to limit the fallout of last month’s seizure of Baoshang Bank Co. The People’s Bank of China (PBOC) and the China Securities Regulatory Commission (CSRC) in a meeting Sunday had promised bank financing support to nine leading brokerages and fund managers in return for their backing of smaller brokerages.

For the Tuesday conference, the PBOC and CSRC summoned six big state-owned banks and some leading brokerage managers to discuss ways to address liquidity risks facing the non-banking financial sector.

It’s not panic stations yet, and the PBOC will very likely cut the cash rate after the Fed, which may ease pressures.

Then again, once the faith in counter parties is gone, it is devilishly difficult to restore. Usually via the always generous tax payer.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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