Baoshang Bank’s takeover by the PBoC happened three weeks ago. However, big banks and brokers are still desperately trying to anticipate the next Baoshang. So much so that many have started to develop a “white list” rather than a “blacklist” when considering lending to smaller banks.
To ease the panic, “Mother PBoC”, as onshore bankers call it, has been forced to use extraordinary measures to incentivise lending to smaller financial institutions.
In the three days following the takeover, Rmb400bn ($58bn) was injected into the China market. A week later, when Bank of Jinzhou became the next bank to come close to crumbling, the central bank found a way to provide credit enhancement to all of Jinzhou’s negotiable certificates of deposit. In addition on June 14, PBoC added Rmb100bn to its standing lending facility quota. This quota was only used once in history on a small scale in 2015.
But the liquidity crisis soon spread to China’s non-banking sector too. Smaller brokers are finding it increasingly hard to refinance themselves as bigger banks and brokers reject their collateral, even if they are high-rated bonds issued by state-owned enterprises. To fill that hole, the China Securities and Regulatory Commission and the PBoC summoned nine large brokerages and fund managers, and six big state-owned banks, in the past couple of days, asking them to support their weaker peers.
These measures have stabilised the market to some extent. But what Baoshang brought to light is a web of trading relationships that can be easily broken, largely due to the absence of a mechanism to settle default cases. If the regulators want to help, they need to think longer term.
That said, the PBoC did recently introduce rules to shore up the banking sector. Last Sunday, the central bank included qualified bonds, CDs, and notes as eligible collateral that smaller banks can use to apply for liquidity from the central bank. While it is a good first step, more clarity is needed. For instance, the PBoC did not define, at least not publicly, what it means for a bond to be “qualified”.
Similarly, regulators also introduced a trial programme, allowing lenders to conduct blind auctions of “pledged repo contracts”, the dominating type of repo contracts in China. But bankers say that this programme is unlikely to help much either.
Why? Because pledged repo contracts are unique to China. Compared with a normal repo contract, a pledged repo allows the borrower to retain the bond’s ownership. The repo bonds are entrusted to a third party — usually China Securities Depository and Clearing (CSDC). If the repo bond defaults, the lender will have to negotiate with the borrowers for disposal terms. But if no agreement is reached, the lender doesn’t have the right to dispose of the bond.
Onshore bankers admit these bilateral negotiations rarely work. As a result, the lender is left with two choices — seek legal action or rely on the CSDC for auctions.
But the auction process has been described by bankers as “troublesome and time-consuming”, meaning it is unlikely to be taken up seriously.
To de-risk the banking sector, regulators need to come up with longer-term measures that slowly erase investors’ assumptions about the government’s implicit guarantee for all banks. To de-risk the non-banking sector, they should introduce effective rules to ensure defaults can be handled in a timely manner.
Only then can China’s banking sector see stability.