Serious Trouble Erupts In China's Interbank Lending Markets

Following the FOMC announcement (although there is probably no direct causal relationship, it is still noteworthy that this temporal coincidence occurred), interbank lending rates (SHIBOR) and repo rates in China went absolutely ballistic overnight. Allegedly a speech by prime minister Li Keqiang was responsible for the turmoil, but we actually have some doubts about that – although it can of course not be ruled out that it was a contributing factor.

According to Bloomberg:



“China’s benchmark money-market rates climbed to records as the central bank refrained from using reverse-repurchase agreements to address a cash crunch in the world’s second-biggest economy.

The People’s Bank of China didn’t conduct open-market operations to add or drain funds today and sold 2 billion yuan ($326 million) of three-month bills. Maturing notes added a net 28 billion yuan to the financial system this week, after increases totaling 252 billion in the last two weeks. Chinese banks need to step up efforts to support economic reforms and do more to contain financial risks, the central government said yesterday after a meeting led by Premier Li Keqiang.

The seven-day repurchase rate, which measures interbank funding availability, rose 270 basis points, or 2.70 percentage points, to 10.77 percent in Shanghai, according to a daily fixing announced by the National Interbank Funding Center. That was the highest in data going back to March 2003. The one-day rate rose by an unprecedented 527 basis points to an all-time high of 12.85 percent, a separate fixing showed. An intra-day gauge of the one-day rate touched a record 30 percent.

“The market’s move is not just because of liquidity but due to a policy stance that won’t change,” said Zhou Hao, a Shanghai-based economist at Australia & New Zealand Banking Group Ltd. “After Li’s statement yesterday, the market now sees the crunch lasting longer. Until after mid-July, liquidity won’t get better significantly.”


(Emphasis added)

Allow us to point out here that such a major crunch in the interbank lending market is surely not happening 'on purpose'. No central bank watches with equanimity when rates in the interbank lending market go absolutely haywire.

Here is an overview of SHIBOR rates from the overnight to the 6 month rate – this certainly looks like something is going seriously wrong in China's banking system:



Shibor overviewSHIBOR goes haywire across the maturity spectrum, but the yield curve continues to  be completely inverted – click to enlarge.



As can be seen, the inversion of the yield curve is worsening, but more importantly, SHIBOR has now clearly broken out above the technical resistance level that was provided by previous spike highs.

In other words, this spike is of a different quality than previous ones. It indicates that trust between banks is eroding fast, and thereby tells us indirectly that the faux 1% NPL ratio reported by China's banks is indeed masking a far worse underlying reality. Our bet is that large upsets in China's 'shadow banking' are occurring, very likely one or several of the investment trust products used by the banks to circumvent government credit restrictions are about to blow up.

If so, then a major credit crisis is about to engulf China. This will have repercussions around the world.



SHIBOR-onA close-up view of the overnight SHIBOR rate – the previous all time high has been exceeded by a huge margin now – click to enlarge.




We believe that similar to emerging market bonds and currencies, China may now be a victim of a reversal of capital flows induced by the Bank of Japan's unprecedented stimulus measures and the associated collapse in the yen's exchange value. Such actions always reverberate around the world, and we know since the Asian crisis of 1997-1998 that whenever either the yen or the yuan or both are weakening sharply relative to other currencies in the region, upheaval soon follows. This time, China appears to be one of the main victims of these developments, as the yuan has remained firm during the yen's recent collapse.

There has been a vast credit bubble in China, with banks employing ever more dubious methods to expand credit further. Associated with this credit bubble was malinvestment of capital on a truly colossal scale. Now it appears the chickens may be finally coming home to roost.

The recent plunge in China's stock market has continued as well:




The Shanghai stock index keeps falling – click to enlarge.



It will be interesting to see how the authorities react to these developments. It could well be that things are already out of their control.



Charts by: Shibor.orb, BigCharts




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9 Responses to “China’s Latest Credit Bubble Convulsions”

  • All-Your-Gold-Are-Mine:

    Unsurprisingly, the Chinese interbank lending market did ease slightly overnight on Friday (see SHIBOR link below), and the Chinese open was also the coincident event that saw Gold pop $20 off its lows overnight in the wake of Thursday’s cliff dive.

    On another site, I explained how Gold’s plunge was more related to the spike in SHIBOR rather than Bernanke’s tapering comments as everyone assumes. Another idea proposed was that the PBoC could use its hoard of US Treasurys (instead of printing Yuan- again as it seems everyone assumes) to alleviate its interbank problem…

    The West seems clueless that the PBoC purposely created this self-imposed credit crunch to send a strong message to its member banks. For anyone following the developments over the past several years, one wou;ld know better.

    Now the very people that are assuming this will be bad for gold will be surprised again when they learn that the PBoC (having already sent their message) will eventually relent by injecting Yuan into the banking system to relieve the current stress…. mission accomplished. Gold will then rise in price setting up the short squeeze in that lop-sided trade.

  • peter hays:


    If emerging currencies continue plunging, is it
    Conceivable they dump their US dollar holdings
    To support their own currencies to stabilize if they don’t want
    To raise rates?

    Could china do the same with its usd reserves to bail out
    It’s own banking system ?

    Japan repatriated funds after Fukushima and the dollar dropped lower as yen rose in 2011

    Could the inflation tables be turned on the USA ?

    • That cannot be ruled out. Specifically, a number of EM central banks are already using their large reserves to intervene and try to stop the bleeding. That is very likely one of the reasons why there is now also pressure on treasury bonds.

  • Andrew Judd:

    However, the Chinese leadership is refusing to add liquidity and is even removing liquidity. They appear to have a deliberate policy to punish over levered players and in particular deal with shadow banking so that lending can be targeted towards the lending they want and away from the lending they do not want.

    Presumably the leadership expected cooperation from the banking system and did not get it and now they are showing them who is actually in charge even if this means growth targets are at risk.

    • Yes, it has been reported that they are reluctant to help. It seems to me though that the process quickly worsened beyond what they expected. However, I agree it is not out of the question that the new leadership may even be prepared to accept a few casualties in the banking sector in order to establish its new economic agenda. That argument has for instance been made by Chris Wood of CLSA and he is quite well versed in matters concerning China.

  • zerobs:

    Seems like the Chinese won’t be able to buy as many US Treasuries as before.

    • There is no telling how much hot money is in China. I suspect there was so much intentional nonrecognition of the brewing problems in China due to the need to find a bigger sucker to buy out positions, so the money could leave. I read something to the effect 5 years ago that they were using import orders to hide hot money flows into the country. A country that expands that fast has massive import needs, so it is quite likely the import numbers have been skewed for a decade or more. Also, as long as dollars keep coming, China will keep buying bonds. It has been clear to me and I know of many others that China has been floated on fictional credit for a long time, a nationwide economy on a subprime bubble.

  • bubbly:

    This is one of the main reasons why gold is going down.

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