Redback relish

Source:Reuters-Global Times Published: 2014-3-9 23:43:01

Chinese 100 yuan ($16.32) banknotes are stacked at the Korea Exchange Bank headquarters in Seoul, South Korea, on February 27. Photo: CFP

Deposits denominated in China's yuan currency have exploded in South Korea as local subsidiaries of Chinese banks tap into Korean investors' hunger for higher-yielding assets.

It has also opened a channel for the Chinese lenders to raise cheap yuan funds and use them in their domestic market to extend loans, enjoying fat margins amid the backdrop of tight monetary conditions in the world's second-largest economy.

The fast pickup of yuan deposits in Seoul has left market participants wondering if the yuan pool there will exceed that in more established centers such as Singapore and London, despite a dramatic slump in the "redback" in the past two weeks against the US dollar, or "greenback." Yuan deposits by local residents in South Korea stood at the equivalent of $7.62 billion at end-February, more than eight times that at end-September 2013, data from its central bank showed Friday. That also compares with $170 million at the end of 2012. 

That amount is already quite competitive compared to London, which saw yuan deposits from personal and corporate accounts at only 3.1 billion yuan ($504.64 million) at the end of last June, according to the latest data.

Higher returns

What makes yuan deposits in Seoul different from those in Singapore or London is that the won, South Korea's currency, cannot be directly converted to yuan, making yuan deposit transactions there complicated. Unlike Hong Kong, Taiwan, London and Singapore, South Korea is not an authorized offshore trading centre for the yuan.

Yuan deposits in Seoul were built through a structured product scheme in which a local brokerage sold asset-backed commercial paper to raise won from local institutions such as insurance companies.

The proceeds were then swapped into dollars, before they were converted to yuan and put in local subsidiaries of Chinese banks, which then send the money back to China to fund their business there.

These structured products generate an annual return in the low 3 percent range, better than won deposit products which usually offer returns in the high 2 percent range, according to bankers in South Korea.

"The Chinese banks will send the money back to their headquarters," said a Bank of Korea official who spoke on condition of anonymity because he was not authorized to talk to the media.

"I understand there is an increase in higher-rate loans in China due to a shortage of funds, so the Chinese banks end up with a substantial margin even if they offer comparatively higher interest rates on deposits in Korea," the official said.

The People's Bank of China (PBC), China's central bank, is expected to keep a relatively tight monetary stance after two cash squeezes it engineered last year to discourage banks from riskier lending. Funding costs in the Chinese mainland also face upward pressure as the government accelerates reforms in the domestic financial market.

Analysts say demand for yuan products in Seoul is likely to be sustained, given that favorable currency swap rates will continue to bring returns from these products, but the pace may be slow as regulators have expressed concern about the rapid growth.

The Financial Supervisory Service, a South Korean financial regulator, already instructed Chinese bank branches in Korea to slow their yuan deposit-building late last year.

Yuan deposits by local residents rose by $60 million in February from the previous month, slowing substantially from a rise of $2.5 billion in December and $860 million in January.

But officials say that any change in regulation or new rules in response to the yuan deposit growth are unlikely at present.

South Korea's central bank chief said that a recent spike in domestic deposits of Chinese yuan in South Korea was not a major cause for concern, suggesting that no serious measures were planned to limit local yuan accounts.

"I don't think this is a cause for concern," Bank of Korea Governor Kim Choong-soo told reporters at a briefing following the central bank's monetary policy meeting on February 14.

"There has been an increase in arbitrage trade because of the deleveraging in the Chinese financial system," Kim said.

Favorable swap rates

The yuan was a regional bright spot last year, gaining nearly 3 percent against the dollar, outperforming most of its emerging market peers.

But it has retreated sharply in recent weeks, with China's central bank believed to be punishing speculators who are making one-way appreciation bets on the currency.

Still, most analysts believe its long-term appreciation trend remains intact as the Chinese government encourages broader international usage of the currency to rival the dollar.

Greater volatility is unlikely to affect the enthusiasm for yuan-structured products sold in South Korea, as foreign exchange rate risks have already been hedged by cross currency swaps (CCS), analysts say.

Moreover, they believe the low level of dollar/yuan CCS rates at present will boost sales of yuan deposit products in the country.

"Right now investors can get a hedge premium on the dollar/won swap, and a cost on the dollar/yuan swap. But the premium from the dollar/won side outweighs the costs," said a banker in South Korea.

Investors who buy one-year yuan deposit products and swap them to the won can enjoy a yield pickup of about 90 basis points over conventional won deposits, while the pickup was non-existent half a year ago, said Becky Liu, a strategist at Standard Chartered Bank in Hong Kong.

"The current favorable swap levels could add to the continuing strong demand by local investors to pick up the additional return," Liu said.

Reuters - Global Times

Posted in: Insight

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