China central bank holds line on shadow banking as rates spike

Fri Jun 21, 2013 10:45am EDT
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By Gabriel Wildau and Jason Subler

SHANGHAI/BEIJING (Reuters) - China's central bank faced down the country's cash-hungry banks on Friday, letting interest rates again spike to extraordinary levels as it increases the pressure on the banks to rein in rampant informal lending and speculative trading.

The banks have been using cheap official funds to finance the vast "shadow banking" market, which Beijing worries is siphoning credit from industry and creating asset-price bubbles.

The People's Bank of China (PBOC) has tried to put an end to this over the past three weeks, declining to inject significant funds into the money markets even as the interest rate for some banks to borrow short-term funds has soared to 25 percent or higher.

"They are trying to take a different approach to rein in shadow banking activity," Charlene Chu, senior director at Fitch Ratings, told reporters on the sidelines of a conference in Sydney.

"This new approach, where you are trying to tighten the funding in the system available for that type of credit, is much more effective, but it is also taking the market by surprise."

Cash remained expensive at least for the smaller banks, though the weighted average overnight bond repurchase rate -- a measure of the cost of funds -- fell to around 9 percent by midday from Thursday's close of 11.62 percent.

Some worry the PBOC's hardline approach could be a risky strategy, creating the potential for defaults and gridlock in the money markets of the world's second-largest economy, as happened in the West after the collapse of Lehman Brothers in 2008.

Some calm returned on Friday after rumors of some major banks needing emergency funding were quelled. There was also market talk the central bank had guided the biggest state lenders to provide more short-term funds to smaller banks.   Continued...

Damaged 100 yuan banknotes are seen at a branch of China Bank in Foshan, Guangdong province, June 5, 2013. REUTERS/Stringer