Forget U.S. talk of monetary “tapering”: to see what it really looks like when liquidity is sucked out of the market, look to China. A standoff between the People’s Bank of China (PBOC) and the country’s overextended lenders has pushed short-term interbank rates to record highs. China’s closed and state-controlled financial system has a better chance of averting the kind of meltdown that took place in the United States and Europe during the financial crisis. But everything hinges on the authorities’ ability to react quickly and decisively.
For anyone who watched the events of 2008 unfold in Western financial markets, the sight of Chinese banks charging each other 25 percent for overnight money – as some apparently did on June 20 – looks like a sign of impending disaster. The reality is less severe, though still serious. Some banks – probably smaller and mid-sized lenders – are short of liquidity ahead of the end of the quarter. One explanation is that they have been funding loans by issuing off balance sheet wealth management products. Now that regulators are cracking down, banks are being forced to fund these loans themselves.
So far the PBOC, led by governor Zhou Xiaochuan, has refused to intervene publicly, maybe to teach overextended banks a lesson. But it’s unthinkable that the central bank would allow any Chinese lender to fail. Indeed, the PBOC could well be supporting individual institutions behind the scenes. The state-controlled banking system gives the PBOC more power over individual banks than its counterparts in the West. Moreover, China’s mostly closed capital account means it doesn’t have to worry so much about cash fleeing the country.
Even so, it’s still possible that something could go wrong. With nerves on edge, a missed payment from a bank to its own lenders could set off a chain of reactions that would prove hard to contain. If depositors fear they won’t be able to access their savings, or if a wealth management product fails to pay out, unrest could ensue.
The opaqueness of China’s financial system may be helpful at times. Problems can be smoothed over without investors or depositors knowing anything is amiss. But if trust were knocked, a lack of transparency could quickly become a weakness, and the authorities’ ability to prevent a worse crisis would be severely tested.