The Chinese Central Bank Freaked Out Over A Bank Lending Spike Unlike Anything It Had Ever Seen Before In History

china chess dominos brokerage shanghai stockPeople play chess in front of an electronic board showing stock information at a brokerage house in Hefei, Anhui province, February 18, 2013.

The final two weeks of June were characterised by market turmoil that seemed to stem from the actions of two central banks.

First there was the Fed actions. Talk of the “taper” caused US interest rates to jump and equity markets to fall, as traders started to anticipate monetary tightening at an earlier date than previously thought.

But at the same time, in China, there was a spike in SHIBOR (which is China’s equivalent of LIBOR) which screamed cash crunch for China’s banks.

That too freaked markets out, and now thanks to Lingling Wei and Bob Davis at WSJ we have a better idea of why SHIBOR (which has since calmed down) spiked so hard.

Basically (and this was suspected at the time) the People’s Bank of China let the rates spike as a tough measure to induce a level of tightening and discipline in the banking system.

What caused the PBOC to do this?

According to a previously undisclosed summary of a PBOC internal meeting on June 19, the central bank was especially concerned that in the first 10 days of June, Chinese banks increased lending by 1 trillion yuan ($163 billion)—an amount the central bank said “had never been seen in history.” And about 70% of that amount consisted of short-term notes that mostly don’t show up on banks’ balance sheets—making it easier for the banks to get around regulatory lending restrictions-—rather than lending the money to promising companies or projects.

The PBOC evidently took that lending spike to be a sign of an expectation of further easy policy, and so the response was to do the hard opposite, let interest rates spike, and basically give the banks the back of the hand, letting them know that their risky behaviour would not be rewarded.

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