2014-03-04

Stars Aligning For A March Cash Crunch as PBOC Drains Liquidity

First some English language coverage of the trust situation from Bloomberg:
China Banks Show Too-Connected-to-Fail Link to Loans
Du Ronghai received an urgent phone call from his private banker at Industrial & Commercial Bank of China Ltd. about an investment opportunity promising a 10 percent annual return. Only for the privileged few, he was told.

Du, who owns an apparel manufacturer in southern China, said he hopped on a plane the next morning for a four-hour flight from his home city of Harbin. That afternoon, at an ICBC office in Guangzhou, he looked at the sales contract he was required to read in person and invested 3 million yuan ($488,000), his first foray into the high-yield world of shadow banking. The employee kept telling him the product, called a trust, was so good that bank staff were pooling money to buy it, he said.

“I knew nothing about it, but the return was very, very tantalizing, and the way they presented it was like if I don’t buy it now, someone else will grab it in seconds,” said Du, who at the time, about two years ago, had almost 30 million yuan parked at Beijing-based ICBC in deposits earning less than 3 percent annual interest. “I was thinking, if I can’t trust ICBC, who else can I trust?”
High pressure sales tactics and a total trust in the financial institution. Not a good mix. Turns out Mr. Du invested in the infamous "Credit Equals Gold" trust.
That figure is equal to more than 80 percent of banks’ shareholder capital and has increased 65 percent annually for the past three years, Werner wrote in a Jan. 22 note.
The figure referred to is the total amount of shadow banking assets.
The top three shareholders of Beijing-based China Credit Trust are state-owned enterprises, including People’s Insurance Company (Group) of China Ltd., which owns a 33 percent stake and is the trust’s biggest investor.
This is why yuan depreciation is the most likely course of action: the central government is already intimately involved in the financial system.
“China needs a default, but not now,” said Xu Gao, Beijing-based chief economist at Everbright Securities Co. “A default would lead to an exodus of capital from similar financial assets, followed by a bank run, as liquidity is quickly drained in the financial system. Nobody will be willing to lend to each other -- just like what happened when Lehman went bankrupt. This is simply unaffordable to the government which has repeatedly vowed to avoid systemic risks.”
Default never comes when you want it. When times are good, bad debts can be serviced. It is when the economy sours that a default can cleanse the system. Repeated bailouts teach the financial sector that they will never be responsible for their bad decisions.
China has a record of bailing out banks in distress. In the late 1990s, it injected 270 billion yuan of capital into the four largest lenders, which were then on the brink of bankruptcy, and carved out 1.4 trillion yuan of nonperforming loans from their books. Since 2003, the government has spent $79 billion recapitalizing the firms and wiped away another 1.4 trillion yuan of bad loans.

A bailout might not be as easy this time around. China’s nebulous world of shadow banking, which includes trusts and wealth-management products, as well as guarantor and underground financing, accounted for 84 percent of GDP in September 2013, rising from 70 percent at the beginning of that year, according to JPMorgan.
The bailout in the late 1990s was a simple matter. The country was growing fast and accumulating reserves. Now, reserves have stopped growing rapidly and in fact are likely to start winding down soon, having already peaked as a percentage of GDP.
For Du, the roller coaster of Credit Equals Gold didn’t stop him from putting more of his savings into trusts. He said he has recently bought similar products from other banks, including China Minsheng Banking Corp. (1988) and Shanghai Pudong Development Bank Co. (600000), and will continue to invest.

“The risk is not with trusts, it’s about which bank you plan to partner with,” said Du. “I’m totally done with ICBC and now going with the smaller ones because they are more willing to honor what they said.”
Fool me once, shame on you. Fool me twice......

China Central Bank Guides Short-Term Rates Higher
China's money market interest rates jumped on Tuesday after the nation's central bank withdrew more liquidity from the financial system, signaling that it intends to continue its efforts to rein in risky lending and facilitate economic restructuring by guiding rates higher.

A benchmark cost of short-term loans among banks, the weighted average of the seven-day repurchase agreement rate, rose to 3.52% from 2.82% at Monday's close.
Heading for another cash crunch.....
However, analysts said they expect the PBOC to be less aggressive in guiding money market rates higher in the coming months than it was last year, given recent signs that the nation's economy is slowing.

To help curb risky lending, the Chinese central bank has engineered four cash crunches in the financial system since June, pushing the benchmark borrowing cost to around 4%-5%, compared with 2%-3% before the summer funding squeeze.
Engineered is too strong of a word. The Chinese central bank has, except for September, allowed the market to panic briefly before bailing everyone out. It's true that borrowers and lenders across the economy are behaving more cautiously, a result of the well publicized default of "Credit Equals Gold" in January. Whether the PBOC is able to put enough scare into everyone is another question. Mr. Du clearly hasn't learned his lesson. But engineered assumes the PBOC created the situation. It didn't.

There is a real scarcity of real capital in the Chinese economy. Interest rate liberalization has quickly led to the growth of products such as Yu E Bao, which soaked up billions in assets and offer much higher interest rates. Rates are high because money supply growth (inflation) is high, but real capital is constrained by the financial system, while malinvestment is high due to savings being allocated based on politics, not profits. If the central bank did nothing, there would be widespread bankruptcies and defaults across the entire financial system. Instead, the central bank let's everyone get close to the edge and the pulls back.

This strategy can work if the economy stays strong, but if it weakens, the central bank will run out of good options.

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