China’s top banks could issue NCDs as early as next month, using the interbank offered rate as pricing guidance. This is another step towards developing an interest rate regime that is determined by market demand and supply.
Large Chinese financial institutions are expected to win approval for the issuance of tens of billions of renminbi in NCD in September, according to Reuters.
These instruments would enable banks to access large amounts of funds at relatively stable costs, providing some alternative to borrowing from the interbank market where the cost of funds can be volatile as was seen in June when a liquidity crunch temporarily sent short-term money market rates to nearly 30% higher.
“The banks can currently lend to each other anyway but it’s not very transparent and once the lending is done it’s not really transferable,” said Bin Gao, Hong Kong-based interest rate strategist at Bank of America-Merrill Lynch (BoA-Merrill) to Asiamoney PLUS on August 23. “To have formal CDs issued [on the interbank market], it helps the market know where capital is being priced.”
“When the bank needs liquidity, they can unwind their position if they hold the CD and they can transfer it to another bank,” he added. “This will overall help the banks to manage their liquidity better.”
Additionally, the NCD would be offered with tenors from three to six months and be priced with a premium over the Shanghai interbank offered rate (Shibor), say experts.
This is the most noteworthy development as it could potentially boost the credibility of the interbank reference rate. Interbanks rates have come under scrutiny in other parts of the world as a result of the Libor scandal which have seen large international banks fined for manipulating rates.
“It will be based on Shibor, which is the market rate,” said Frances Cheung, senior strategist Asia ex-Japan at Crédit Agricole. “It will reflect the actual cost of funding and is also a sign that regulators want to push through liberalisation on the deposit side.”
“People will be betting on more utilisation of this curve,” she added. “If secondary liquidity improves, it could improve the credibility of the Shibor mainly because more deposits and bank loans will be based on the market rate.”
The People’s Bank of China (PBoC), under the helm of reform-minded Zhou Xiaochuan, has been trying to promote the role of the Shibor as the benchmark for short-term borrowing costs.
“I feel that repo should be the benchmark as it is more market friendly, much more liquid and there are more transactions but for repos the transactions are concentrated on the overnight to seven days. Anything longer than seven days the trading volume drops significantly,” said a Hong Kong-based rates strategist. “But Shibor is a three-month rate, so it will naturally be a benchmark rate for the NCD. The seven-day Shibor is fixed after the seven-day repo anyway – so they are pretty much the same.”
Bank of China (BoC), the Industrial and Commercial Bank of China (ICBC), Agricultural Bank of China (ABC), China Construction Bank (CCB) and Bank of Communications (BoCom) have submitted their plans for NCDs to the central bank, according to Reuters.
Despite this positive development, there are still some concerns with the usage of Shibor as a benchmark rate for NCDs. This is because the curve of Shibor is very steep, suggesting that it could be costly for banks to seek for three- to six-month funding via this route.
“They might not want to borrow too long a tenor because the premium is very high,” said Becky Liu, senior rates strategist at Standard Chartered. “Instead of borrowing upright for six months, you probably would just be doing seven days and just keep rolling it over.”
Also, allowing only the bigger banks to participate in this pilot programme may not trigger any material secondary market activity. This is because these large-sized financial institutions are well capitalised to begin with.
“The bigger banks would be the ones that have better access to capital rather than the small- and medium-sized ones,” said Liu. “If the NCD is calculated in the loan-to-deposit ratio – which means that the deposits that they get under this scheme can be used for loan purposes – it would even strengthen their position in the loan market and it would hurt the smaller banks even more.”
“To me the smaller banks would be the ones that would be more willing to pay,” she added.
Fear of another liquidity crunch that resulted in the spike of recent overnight rates could be a factor to why the Shibor should not be used as a reference rate for NCDs.
In June, China’s money market was atypically illiquid after PBoC refrained from injecting capital into the system through open-market operations, resulting in a spike in overnight lending rates from 3% in early May to as high as 13.44% on June 20.
But this is unlikely to happen again, believe experts.
“The central bank has indicated they want to cap the seven-day repo rate at 3.9%,” said BoA-Merrill’s Gao. “I don’t expect any sustained spike in short-term rate. There might be a possible one-day spike but I think the PBoC will be more active in order to cap the rate level.”
The PBoC has been following a step-by-step approach in liberalising interest rates, shifting its focus on loosening controls on bank deposit rates after it freed up bank lending rates in July.