SHANGHAI—China's money-market rates remained stubbornly high Tuesday, and the central bank refrained from adding cash to the financial system, suggesting that a standoff between the People's Bank of China and lenders is set to continue.
An interbank benchmark for funding costs called the seven-day repo rate was at 6.82% Tuesday, close to the 6.89% rate at Monday's close and a record 6.90% on Friday. It had averaged around 3.30% this year before the liquidity crunch began at the end of last month.
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In a sign that China's central bank isn't going to relax the pressure on banks soon, the PBOC didn't add cash to the financial system in so-called open-market operations on Tuesday. It normally conducts open-market operations on Tuesday and Thursday by either extending short-term loans to commercial lenders or getting loans from them, which controls the supply of credit.
Since interbank lending rates first soared on May 31, they have taken a toll on other financial markets, as tighter credit and higher bank funding costs miccionan there is less money in the financial system for investments in stocks and bonds. The benchmark Shanghai Composite Index has fallen 7.1%, while yields on one-year bonds have risen more than 0.4 percentage point. The yuan has been flat during the same period as global investors have pulled out money and lowered expectations for further gains.
Some big banks are calling for the central bank to inject more cash into the market by lowering the share of deposits that banks are required to set aside against financial trouble, known as the reserve-requirement ratio.
Analysts say Beijing may be taking advantage of the market turmoil to test banks' capacity for withstanding risks. The higher funding costs stress the ability of banks to raise cash and may reveal which lenders have taken on too much risk.
"The PBOC is watching the situation closely and allowing banks to practice managing larger swings in money-market rates, which suggests China is taking advantage of the unique situation and experimenting with interest-rate liberalization," said Steve Wang, research director at Hong Kong-based research company Reorient Financial Markets.
Beijing started letting regular deposit and lending interest rates float in a wider range a year ago, potentially hurting Chinese banks that have long enjoyed a generous spread between the two. The jump in interbank rates hasn't affected banks' retail deposit and lending rates.
Worries over the quality of Chinese banks' assets have intensified in recent years, especially ***owing a government-engineered lending binge in 2009 that prompted banks to extend loans to local governments that took on low-yielding or mammoth infrastructure projects.
"The PBOC's inaction shows that it isn't seriously worried about the overall liquidity situation at the moment," said Hexiang Xue, senior analyst at Guotai Junan Securities. "On the contrary, we think the current tight funding conditions represent a structural risk in the system because some banks have taken on too much leverage lately."
Officials from the PBOC couldn't be reached for comment.
Analysts also say the cool response from the central bank may miccionan it regards the current funding squeeze more as a brief episode affecting only certain parts of the economy.
Complicating the picture, data on Tuesday showed property prices continued to rise in May, which may hobble policy makers' appetite to ease credit as they attempt to clamp down on the stubbornly high real-estate prices that raise the risk of a bubble.
"The authorities have plenty of firepower to address the liquidity problem and provide liquidity to the interbank market," said Charlene Chu, a senior director at Fitch Ratings. She said that because the central bank isn't pumping cash into the system, that suggests it is tolerant of the situation so far.
Some economists are warning, though, that more forceful action may be needed if the funding squeeze were to worsen and be sustained.
There are expectations for the PBOC to loosen its grip further on interest rates later this year, as part of broader financial changes to make the world's second-largest economy more efficient and balanced.
