Small change

26 June 2013 By John Foley

A pledge of support for cash-strapped lenders should take the fear out of China’s interbank market. After two weeks of spiking rates, the People’s Bank of China (PBOC) said on June 25 it had extended liquidity to some lenders, and would stand ready to help others. Its new stance will most benefit those in least need: China’s big banks.

For small banks, the PBOC has offered a safety net. Many had been borrowing short-term in the interbank market and investing in longer-term assets which offer higher returns. Rising short-term rates left them facing a squeeze. At Industrial Bank, for example, interbank lending accounted for 38 percent of interest income in 2012, according to Bernstein Research. With interbank rates likely to stay elevated, that trade is no longer attractive.

That leaves small banks in a bind. Many have hit the official 75 percent cap on loans as a proportion of deposits, making it hard for them to engage in new lending. Because deposit rates are controlled they can’t easily attract new funds, while the lack of deposit insurance in China means savers gravitate towards the bigger lenders. That’s partly why small banks have been enthusiastic issuers of short-term wealth management products, which offer savers higher rates.

Banks which are short of deposits are more prone to liquidity squeezes. They must already leave up to 20 percent of their deposits on reserve at the central bank. For those with a further 75 percent tied up in loans, there’s little left to meet payments and withdrawals. China’s four biggest lenders – Bank of China, China Construction Bank, Industrial and Commercial Bank and Agricultural Bank – have no such headaches. Their loans were equivalent to just 61 percent of their deposits at the end of May.

The risk is that the latest rout reinforces the big-small divide. Not only have small banks had a tidy source of earnings removed; with the central bank warning that banks must manage their own liquidity better, many will have little option but to rein in lending. The banking system is safer, but the future for small lenders looks glum.

 

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