The front gate of a Zhejiang branch of Industrial and Commercial Bank of China Photo: CFP

 
China's financial markets calmed down on Wednesday after days of turmoil thanks to the central bank's pledge to prevent a credit crunch, but stocks struggled as investors braced for tougher conditions in the world's second-largest economy.

The People's Bank of China (PBC) said late on Tuesday it had helped some banks and was ready to act again as the lender of last resort for those caught in a short-term squeeze. However, it was also sticking to its stance of tightening market conditions as it seeks to rein in sharp growth in informal lending.

PBC, the central bank, wants to curtail funds flowing into China's vast "shadow" financial system that fuels property and stock speculation and push money into more productive areas of the economy to secure more sustained growth.

But its decision to let short-term borrowing costs soar to extraordinary levels last week fanned fears that a temporary squeeze could morph into a lasting credit crunch.

"Market sentiment has apparently improved somewhat, although the PBC is still expected to stick to relatively tight liquidity policy," said a dealer at a major State-owned bank in Shanghai.

The central bank reiterated its warning to banks that they needed to manage their cash better and rely less on short-term borrowing, adding to expectations of tougher business conditions and possibly slower economic growth.

So while most Asian share markets rebounded from a four-day losing streak, taking comfort from encouraging US economic data and the PBC assurances, Chinese shares struggled to find traction.

The CSI300 index of leading Shanghai and Shenzhen listings staged an afternoon rally to end up 0.1 percent, having been down 1.5 percent, but the financial sub-index on the Shanghai exchange lost 1 percent.

Chinese stocks are down more than 20 percent from February peaks, and have lost about 10 percent over the past week.

Money market dealers were relieved that a full-blown market freeze seemed to have been averted, but said fund flows suggested cash would remain tight until mid-July.

The benchmark seven-day repo rate opened down about a quarter of a point at around 7.20 percent on a weighted-average basis on Wednesday, before inching up to near 7.30 percent, still well above the long-run average of 3 to 4 percent.

End of easy credit?

Several economists taking a longer-term view praised the authorities, saying a bout of market turbulence and a possible economic slowdown were risks worth taking to steer the economy to a more balanced, sustained growth path.

For decades China's rapid ascent has been powered by exports and heavy investment fueled by cheap, readily available credit, including massive spending in 2008 and 2009 at the height of the global financial crisis.

But with China's debt levels continuing to swell and increasing amounts of it being funneled to the shadow banking system, the new leadership of President Xi Jinping and Premier Li Keqiang is working harder than ever to cool down lending.

Yet while the central authorities won plaudits for resisting chasing growth at all costs, its opaque decision-making and communication frustrated and confused market players.

Speaking to Reuters about the experience of the past few days, the top executive of China's biggest bank expressed that frustration with rare candor.

"We hope that in future, policy expectations can be clearer," said Jiang Jianqing, chairman of Industrial and Commercial Bank of China (ICBC).  

"That would help us understand the overall market situation better and more deeply. Those few days, even for us, we were genuinely a bit tense."

He added that ICBC's own liquidity situation was sound and that it was prepared to heed the PBC's calls to lend to smaller banks.

China Construction Bank Corp (CCB), the country's No.2 lender, said on Thursday it has not stopped issuing new loans amid a tightening of credit in the country that has sparked reports some banks may be reining in lending.

 The central bank's words and actions convinced a growing number of analysts that while the worst-case scenario of a credit freeze and banking crisis seemed very distant, the era of rapid growth fueled by cheap credit was also over.

"The policy stance will likely remain tight. The statement indicated that the PBC will stick to 'prudent monetary policy,' which suggests that credit growth will continue to decline in the near term," Nomura analysts said in a note.

The revelation that the PBC had supported unnamed individual institutions came after outages at automatic teller machines and point of sales terminals at two of China's largest banks, which caused concern among the public.

Reform ahead

Banks that find themselves overly reliant on short-term funding face a choice: They can shrink their balance sheets so that more assets are funded by deposits, or they find other more stable funding sources.

If they choose the latter, equity and long-term debt are possibilities. But resorting to these more expensive funding sources would pressure banks' net interest margins, hurting profitability.

China's central bank appears to prefer de-leveraging.

"The central bank appears to be determined to force banks and other financial institutions, such as funds, brokerages and asset managers, to de-leverage," said a trader at a major Chinese State-owned bank in Shanghai.

"That hardline stance suits the recent government policy of clamping down on non-essential businesses by financial institutions, such as shadow banking, wealth management, trust operations and even arbitrage," he said.

An article in a PBC-backed newspaper suggested the cash crunch and a rumored default had provided impetus for China to accelerate the roll-out of a new deposit insurance system.

Such a system would eliminate the need for authorities to bail out individual banks by ensuring that depositors were protected even if a bank found itself short of funds.