China’s biggest banks have thumbed their noses at the government. The Ministry of Finance sold just two-thirds of the 15 billion yuan ($2.5 billion) of bills it offered on June 14, according to Bloomberg. The failed auction is not a vote of no confidence, or a sign that interest rates are too low, but a reflection of reality: banks can get better returns lending to each other.
Tight liquidity has pushed up rates in China’s turbulent interbank market, creating winners, losers and worriers. The winners are banks with money to spare. The likes of China Construction Bank and Agricultural Bank of China can make a profit through interbank lending or bond repurchases. Together, those two activities made for a $31 trillion market in 2012. Rates for short-term transactions have almost doubled in recent days.
The losers are those who have to pay up or go without. For now, that includes the Ministry of Finance itself. The 3.8 percent yield on the 273-day bills it hoped to sell is unappealing when banks can charge each other almost 7 percent for overnight loans. Many smaller local banks are strapped for funds and have no choice but to borrow.
Why have interbank rates risen so high? One reason is that there’s less money flowing in from exports - the central bank soaked up just $10 billion of foreign exchange in May, a quarter of the amount in April . As the end of the quarter nears, banks also scramble to dress up their balance sheets. Many have issued short-term wealth management products that mature close to key dates. Banks need liquidity to repay those products: it’s no coincidence that the 21-day bond repo rate began to spike in early June.
This is a short-term spike, not a systemic freeze. Nevertheless, the failed auction is a reminder that, even in a closed, state-controlled system, the unexpected can happen. That’s a worry for central bankers, who would have to step in if a bank got into trouble. It should also concern regulators, whose job it is to know where the counterparty risks sit in China’s increasingly complex financial system. As bank-to-bank rates rise, so must their disquiet.