Just as America’s Federal Reserve looks set to shut off the money taps, China’s central bank is also getting tough. Last week saw a nasty credit crunch in the Chinese interbank market. Interest rates on weekly interbank loans approached 11%, up from just 3% last month. A seven-day rate shot up to a record 12%. Some banks reportedly charged each other 25% for overnight money.
It was a state-induced credit squeeze, says The Economist. Cash crunches aren’t unusual in China because the central bank’s provision of liquidity is “more ad-hoc” than that of its Western counterparts. This time, the central bank refused to alleviate a cash crunch occasioned by deposits drained by firms paying taxes and consumers withdrawing money before a public holiday. A few days later, the squeeze eased when the authorities injected cash into the system.
The central bank decided to get tough in order to force the banks to “clean up their lending habits”, said Lex in the FT. Regulations in the formal banking sector have been tightened up. But the so-called shadow banking sector – off-balance-sheet loans by banks and lending by non-bank entities – has flourished.
Shadow lending has jumped by around 33% since 2005, notes George Magnus of UBS. One common wheeze is for banks to fund loans by issuing off-balance-sheet wealth-management products. Banks and intermediaries use the interbank market to funnel loans into or out of the shadow banking system so a clampdown is essentially a warning shot to the system to stop reckless lending. Whether it will work, or comes too late to stop China’s credit bubble bursting painfully, remains to be seen.