I saw a post about SHIBOR the other day here on WSO and thought I might add a few cents to the proverbial piggy bank.
Over the past week, the overnight Shanghai Interbank Offered Rate (SHIBOR) has skyrocketed. It rose from 4.5% on May 31 all the way to an all-time high of 13.44% on June 24, before settling back down 5.7% as of today. This caused quite a stir in financial circles around the world and bankers have begun re-asking themselves whether they’re bullish or bearish on China. Read on to learn what to consider as you ask yourself the same question.
First, let’s understand what SHIBOR is: simply, it’s a reflection of the interbank lending rate in the Shanghai money market. You may have (cough, cough) heard of LIBOR. So instead of being London, it’s in Shanghai – same idea though.
So SHIBOR popped to an all-time high last Thursday, meaning it has never been more expensive for banks to lend to each other in Shanghai. What caused the run up? A confluence of a few factors (including a medium-sized bank nearly defaulting), but let’s look some other ones individually:
- Seasonality – corporate tax payments come due soon, so those companies need to juice their balance sheets with some excess cash. Commercial banks’ reserve requirement checks also come due soon. They also need cash. Both of these cause demand for bank loans to go up.
- Recent Policy Initiatives – about half a dozen new policies have been enacted since March, including by SAFE and CBRC, increasing scrutiny on FX-RMB settlements and structures of interbank loans. This further causes banks to need to increase the cash on their balance sheets. Rates for bank loans continue to go up.
- Tight Liquidity – recently, although there is enough liquidity in the system, it’s been rather tight. Within the past 30 days, the PBOC has issued to sets of central bank bills at a value of RMB 2bn each as well as fixed deposit for commercial banks at a total of RMB 40bn.
- Midsized Banks’ Liquidity Mismanagement – This is a more complex one, but basically, smaller banks are by nature required to grow faster than bigger ones. Otherwise, the argument goes, why would you ever invest in a smaller, more risky bank. So they dole out more (riskier) loans. This time, they’ve mismanaged the durations of those loans and need cash to fill in the gaps. Demand for interbank loans continues to go up – rates rise.
- Wealth Management Products – otherwise known as ‘shadow banking’ in China, there is a vast market for various high-yield WMPs. These are often low-quality CDOs sold to Dick and Jane who don’t know any better but packaged by crafty bankers. But the bankers who set these up are really just arbitraging interest rates, say, borrowing at 4% and loaning at 7%. Now just happens to be the time when a ton of loans on the underlying assets of WMPs come due. Take some more liquidity out and what do you get? That’s right, an increase in demand for loans from the banks to fill in the gaps!
So there are actually a few more factors than this, including myriad proposals out there that the central government is originating the whole thing to wash their hands clean of any residual unsavory piece of economic policy – in essence, so they can begin crafting a ‘new and improved’ financial system from scratch. But those are a few of the key drivers of which to be aware.
My take – give it 2-3 weeks and the storm will blow over. Yep, maybe SHIBOR doesn’t return to it’s 2009 lows or even 2012 levels of stability, but this is just one piece of a much larger puzzle that the CCP is trying to piece together themselves.
And don’t watch the PBOC - look at the central government’s movements. After all, the head of the PBOC isn’t even among the most powerful 350 officers in the country, so it’s likely that the big guns aren’t waiting for his phone call at night with a recommendation of immediate policy enactment.
So what do you guys think – bearish or bullish on the banking industry in China? Think this will affect the Shanghai/Shenzhen markets in the long term? What did ever happen to that Chinese demographic miracle? Is this, as someone mentioned earlier on the boards, the ‘canary in the coal mine’ for the Chinese economy?
SB, thanks for the analysis. I'm curious, what is your take on the shadow banking in Wenzhou?
Great post.
I completely agree with you that one has to watch the Politburo to really understand Chinese economics. I don't have much emphasis in China for my own investments, but here is my 2 cents. I think the Politburo would never let rates reach double digit territory without something brewing in the pot. This is likely a first step towards a systemic removal of bad debts accumulated at the regional banking level. I get the feeling that the central government wants to rein in speculative investment (especially those stemming from foreign hot money) whereas the regional governments do not benefit from following such orders. Therefore, a tightening in liquidity is the perfect opportunity for the central government to demonstrate to the regional governments that this policy is no joke. However, I am extremely skeptical about any long term fundamental economic reforms to follow from this event. After all, to the Politburo, what's not broken don't need to be fixed. Stability is the goal; improvement comes second.
Are you kidding? China is a complete trainwreck; the only question is how long can they keep lying about it before everyone stops believing them. Rapidly slowing GDP growth, manufacturing contraction, credit bubble, inflation...
So some banks now are borrowing at >7%, wink wink~
The trust products are promising yields at considerably greater than 7%, more like 15%. Also the liquidity problem that surfaces whenever tons of loans coming due is chronic and rather inevitable as a result of the mismatch in durations between standard bank loans and the short term loans embedded into the trust products.
That is an interesting development that I was not aware of. If I had to guess what the Politburo will do, they will have to first "convince" the provinces that it is in their best interest to deal with bad debts and let the regional governments take the first stab at the problem. The central government would be reluctant to get involved directly as that would be the equivalent of admitting that there is a problem and no one wants that. Starting with provinces with high % of FDI makes sense. I do wonder what actual power this provincial AM would have and how much it could do. Interesting times in China.
Shadow banking has largely become a 'necessary evil' in the Chinese lending system due to tight regulations by the central government on the banking sector as a whole.
As those who frequent this site can appreciate, when there are opportunities to make an extra buck within existing legal frameworks, there will be those who will capitalize on those opportunities, with disregard for longer term consequences for the larger entity (in this case the state banking sector). An important point of note here though is that China is much more local than many people imagine. Provinces in China are huge... and it's tough to regulate them all from Beijing. For example, Guangdong province has over 100M people, which alone would make it approximately the 10th largest country in the world; the 7-10th largest provinces all have about 50-55M people, which places them on par with Italy and France.
My prediction over the medium term (which is merely based in empirical evidence and conversations with those in related industries over here - I have no relationship with banking governors) is that these local governments, which have formed investment vehicles to operate with 'shady' loans will get a slap on the wrist by the central government, but nothing dramatic will change.
Over the longer term (say after 2020) the central gov't will begin to absorb some of these practices and create more forms of state-sanctioned lending policies that operate through local administrative governments but re-route through a centralized clearing house.
As for the China bears who constantly point to the shadow banking system as the future impetus for China's economic meltdown, I really have yet to see an argument that makes me pause for much longer than a few seconds - I personally don't think they have much credence. I find most of them employ the logical fallacy of the 'slippery slope' and predict doom and gloom w/o a substantial defense of why 'the meltdown' will actually occur. Mainly hypotheticals here. However, if someone has a link to a really tight argument here, it'd be much appreciated for a share...
Couldn't agree more - no need to rock the boat.
Now is the time when a special situations group for distressed funds is going to make a killing, due to these mismatches. For all those monkeys based out of HK - keep your eyes on the news and ears to the ground...
Thanks for your explanation and analysis. I agree (based on my limited understanding) w/how the threat of shadow banking has been overblown by the china bears. I know a couple high-net-worth families in China that made a lot of $ (and have subsequently lost a lot) with these shadow loans, but it wasn't the end of the world for them, as they are certainly in a position to absorb the shock (worst case scenario they sell one of the speculation apts they are keeping vacant).
Shibor - Canary in the Coal Mine? (Originally Posted: 06/24/2013)
I'm surprised that the recent Shibor spike hasn't (Shibor is the Chinese version of LIBOR) sparked more concern. After staying at less than 4% for the last year, the 3-month rate has surged to above 5%. The overnight rate has spiked even further to 13%. To put things in perspective, 2011's top five banks by profits included four chinese banks. What is happening?
One major explanation being posited is that this is just the next step in the Chinese government's attempt reduce credit expansion/leverage in the system. However, what if this is a different signal - that of a funding crisis? Such a crisis was prelude to the US-led recession of 2008.
On face, China's metrics are fine (gdp growth of over 7%, large fx reserves, small deficit), the soft landing scenario from rapid growth. However, how much of this growth was economical and indeed sustainable? The overall china argument has been debated ad nauseum centering on non-economical commercial real estate backed by a levered shadow banking system, but could this funding crisis be catalyst for the bears? After all, this is not just restricting lending, it is choking China' banking system.
More specifically the strongest point that is related to this is China's own "Ponzi Scheme" (central bank governor's words) fundamentals in its wealth management products and in others' opinions (see: Chanos) more generally China's shadow banking system. These products essentially allow yet another layer of borrowing short to lend long. However, what happens when funding disappears (a la Lehman 2008) given the vast proliferation of these products?
As a result, what if the funding pop is not by choice? A large flood of liquidity would push the rmb lower, usually okay, but given Fed tapering could push the rmb lower than even what the government/economy wants? Furthermore, fear of this could unfortunately be self-fulfilling because a push to buy usd could lead to more conversion into usd (or non-rmb currencies) ahead of a banking/currency crisis.
(Icon source: http://americansingercanaries.com/ferguson.htm)
One reason there isnt much concern is no one really cares until it affects them. So dont expect to hear about it until it affects the usa.
PBOC can always lower capital requirements for banks to spur lending. I haven't looked into these wealth management products, but from what I've read they seem very sketchy.
The immediate trigger of the current spike in SHIBOR was a mid-sized bank's almost failure to repay its interbank lending, which was only prevented when it obtained short term financing at extraordinary high interest rate.
But yeah it would be very interesting to see how things unravel over the next few days. I believe the last time we sas such dramatic spike in SHIBOR was in 2011 still in the midst of the U.S crisis.
The RMB has been depreciating vs the dollar and a popular trade among many HFs is to short HK listed shares of Chinese banks in the hope that at least some of these would see their equities wiped out when banks fail to make good the myriads of informal/shadow loan obligations they are entangled in.
Anyway, now is a good time for those operating in the special situations/asset backed rescue financing space in China.
shibor more like shitbor am i rite
Fundamentally, pretty much all banks in China are owned by the government so you can say Shibor is just another rate set by the government (Libor manipulating? lol). The trouble is not Shibor but rather mid-sized banks can't get cash from PBOC as easily as they used to. PBOC is not your lender of last resort, it is a policy tool by the government. If Xi & Co. does not want to lend out the money then PBOC would not. This is simply a punishment to the Chinese banks.
As far as I know, few (I mean really few) Americans care about what is really going on in China. They say they do but they don't. As a result, they just apply those hard-proven rules of American economy to that of China, because frankly they know nothing about that country at all. At the end of the day, it is still unknown to Americans how different the economy over there is, and most importantly how powerful the government is to nail down some events like this or even one comparable to Lehman collapse.
Hooray hard-landing geniuses! You are looking so smart.
I agree that it should be worrisome, but it's hard to gauge the true impact b/c the Chinese banks are not private institutions. While the Fed or Treasury's willingness to prop up the banks was questionable pre-2008, China's not going to let one of the four largest institutions fail. Perhaps, not even any of the smaller ones.
The SHCOMP just rebounded in a V-shape in the afternoon trading session due to "unfounded rumors of a PBOC press conference later today in the last hour of trading in which it may provide some impetus for a bounce“ that turned out to be false. Then the PBOC official Ling comes out and announces that liquidity is ample and everything is gucci. Shanghai composite closed at measly 0.2% lower. Same old schtick.
I bet Xi Jinping is trying to punish banks for the shadow lending going on. But in the end they Chinese government controls the major banks so I'd doubt we'll see a Lehman over there. If anything they need to raise the lending cap or abolish that shit all together to reduce the shadow banking system they have over there. But I highly doubt the government will relinquish their power over the banks by abolishing the lending cap rate.
I am confident this is all by design of the Chinese government, I am more concerned by the f'king fed.
Care to elaborate?
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