It has been a while since the PBOC engaged in some “targeted” QE. So clearly following the biggest drop in the Shanghai Composite in 6 months after some abysmal Chinese economic and flow data in the past several days, it’s time for some more. From Bloomberg:
- CHINA’S PBOC STARTS 500B YUAN SLF TODAY, SINA.COM SAYS
- PBOC PROVIDES 500B YUAN LIQUIDITY TO CHINA’S TOP 5 BANKS: SINA
- PBOC PROVIDES 100B YUAN TO EACH BANK TODAY, TOMORROW WITH DURATION OF 3 MONTHS: SINA
Confused what the SLF is? Here is a reminder, from our February coverage of this “stealth QE” instrument.
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The topic of China’s inevitable financial crisis, and the open question of how it will subsequently bail out its banks is quite pertinent in a world in which Moral Hazard is the only play left. Conveniently, in his latest letter to clients, 13D’s Kiril Sokoloff has this to say:
Will the PBOC’s Short-term Lending Facility (SLF) evolve into China’s version of QE? While investor attention has been fixated on China’s deteriorating PMI reports and fears of a widening credit crisis, China’s central bank is operating behind the scenes to prevent a wide-scale financial panic. On Monday, January 20th, 2014, when the Shanghai Composite Index (SHCOMP, CNY 2,033) fell below 2,000 on its way to a six-month low and interest rates jumped, the central bank intervened by adding over 255 billion yuan ($42 billion) to the financial system. In addition to a regular 75 billion yuan of 7-day reverse repos, the central bank provided supplemental liquidity amounting to 180 billion yuan of 21-day reverse repos, which was seen as an obvious attempt to alleviate liquidity shortages during the Chinese New Year. However, it is worth noting that this was the PBOC’s first use of 21-day contracts since 2005, according to Bloomberg. Small and medium-sized banks were major beneficiaries of this SLF, as the PBOC allowed such institutions in ten provinces to tap its SLF for the first time on a trial basis. A 120 billion yuan quota has been set aside for the trial SLF, according to two local traders.
The central bank also said it will inject further cash into the banking system at regularly-scheduled open market operations. This is a very rare occurrence, as it is almost unprecedented for the central bank to openly declare its intention to inject or withdraw funds at regularly-scheduled open market operations. Usually, these operations only come to light after the fact.
The SLF was created as a brand new monetary tool for the central bank in early 2013 and was designed to enable commercial banks to borrow from the central bank for one to three months. Since its creation, however, the SLF program has been used with increasing frequency by the central bank.
The latest SLF is remarkable for two reasons: First, as mentioned earlier, this SLF was expanded to allow provincial-level small- and medium-sized banks, for the first time, to tap liquidity from the central bank. As local financial institutions are usually both the major issuers and holders of local government debt, the expansion of the SLF to include local financial institutions opens a new channel for liquidity to flow from the central bank to local governments. This may suggest that the central bank, which is now on high alert for systemic risk, is willing to share some of the burden of local government, though on a very selective and non-regular basis.
The second key reason is embodied in the following central bank announcement: “[we will] explore the function of the SLF in setting the upper band of the market interest rates.” In other words, in the event that interest rates spike higher due to a systemic crisis, the central bank can intervene, via the SLF, to bring rates back down if it so desires. In addition, the PBOC did not disclose any set cap on the SLF, implying that unlimited liquidity could be provided as long as the market’s rate spike exceeds the bands set by the PBOC.
Most important, the SLF appears to represent the PBOC’s strategy to avert China’s widely-publicized local government debt and banking-system problems. It is worth noting that even though local government debt amounts to 30% of GDP and is growing at an alarming rate, China’s central government is relatively underleveraged, with a debt-to-GDP ratio of only 23%, which is significantly lower than the emerging-market average. Therefore, Beijing has considerable unused borrowing capacity to share some of the debt burden taken on by local governments, which would have the additional positive impact of lowering borrowing costs for those governments.