China’s interbank rates have come down from their peaks in June.
During that time, the People’s Bank of China showed us that the government was willing to stomach short-term pain for long-term gains.
There are six key lessons to take away from China’s interbank liquidity squeeze, according to Standard Chartered’s Stephen Green and Wei Li.
- “The PBoC has a mandate for financial-sector stability, and intends to use it.” — Amid slower economic growth, China’s central bank showed it is willing to “act decisively.” “It is leading the drafting of the financial-sector reform package, which will include both interest and exchange rate reform, as well as plans to open the capital account. The PBoC’s long-held ambition of establishing a deposit insurance system paid for by commercial banks appears to be nearing reality.”
- “The PBoC sees itself as the lender of last resort, not the lender of first resort.” — Chinese interbank rates surged on June 17 with the overnight repo hitting 25%. The PBoC could have intervened with short-term liquidity operations (SLO), instead it asked the bigger banks to ensure that smaller cash strapped banks had access to liquidity and said it would only step in if there was a “significant payment default.”
- “The central bank’s communication strategy could be improved.” — Markets got increasingly edgy during the interbank spike as the central bank remained silent for the worst of the spike. The first communication came on June 24.
- “The impact on wealth management products (WMP) issuance is still unclear.” — It was argued that the central bank also let interbank rates rise to punish banks that have a large share of 28-day WMPs. “However, the interbank squeeze also clearly increased competition for funds, and WMPs are one of the few ways in which banks can compete for retail deposits. As a result, it is unclear to us what impact the June squeeze will have on overall WMP issuance.”
- “Interbank rates will remain elevated unless the economy weakens.” — There will be a new normal in interbank rates at around 4%. But the central bank might step back if the economy weakens further.
- “We expect credit growth to slow a little.” — This won’t however be sharp, and it won’t be a significant blow to the economy.
This has shown Premier Li Keqiang’s willingness to reform China’s economy.
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