Some Chinese Banks Suspend "Interbank Business" As Regulator Demands That Collateral "Actually Exists"

Tyler Durden's picture

With "risk" in most of the developed world seemingly a long forgotten four-letter word, as seen by today's plunge in the VIX to a level not seen since 1993, traders hoping for some "risk event" have been confined to the recent turmoil in China, where overnight not only did trade data disappoint, with both imports and exports missing, but bond yields jumped to the highest level since 2015, dragging stocks lower even as the local commodity crash slammed iron ore and copper to new YTD lows.

While largely a "controlled" tightening, meant to contain China's out-of-control shadow banking system, the recent gyrations in Chinese capital markets are starting to have a profound impact on local funding, resulting in a collapse in new bond issuance, and according to FT calculations, in April the number of aborted issues rose to 154, up from 94 in March, 32 in February and 31 in January. 

As DB added, "local bond markets are practically shut for corporates. In fact, YTD issuance is down 40%+ yoy and net issuance has been negative in three out of the first four months this year. A number of issuers are being forced to cancel bond issuances (over RMB100 billion YTD) and there were reports (Bloomberg) of even CDB halting issuance (though subsequently denied). Some AA corporates are now issuing at north of 7%."

These signs of mounting stress in China’s $9.3 trillion bond market come less than a month after the country’s banking regulator, Guo Shuqing, was quoted as supporting a campaign to sort out chaotic practices, and threatening to resign if the banking system became “a complete mess”.

Overnight, Deutsche Bank's China analyst Harsh Agarwal noticed the "gyrations" in the bond market, and compared the current selloff in onshore bonds to the similar episode one year ago, saying "this time, it's sharper and longer - AAA yield & spreads are almost 200bp and 100bp wider respectively in the past 6 months or so - because of China's focus away from growth to deleveraging. This is far from over in our view. Every day we see headlines on new regulations trying to control leverage in different parts of the system - WMPs, insurance companies, banks, etc. Having said this, we do believe in China's ability to make a U-turn quickly if the situation goes beyond control, and see these changes as a long term positive, hence we are not overly worried as of now."

Maybe not as of now, but Agarwal is surely getting more concerned with every incremental negative news out of China, even as the PBOC refuses to inject more liquidity, as it just did moments ago when for the third day in a row, the central bank skipped open market operations.

Meanwhile, confirming that Beijing is clearly concerned about developments behind the scene, potentially culminating in the worst possible case for China's banking system - a shadow bank run -China Banking Regulatory Commission said in guidelines on banks’ collateral management posted on its website.

Commercial banks should carry out pressure tests on collaterals at least once a year, China Banking Regulatory Commission (CBRC) posted new guidelines on banks’ collateral management, among which that banks should revalue collateral at least once a year; and that banks are being urged to prevent risks in the collateral business. Of course, since this is the country where due to "infinite rehypothecation" of collateral, thousands of tons of copper and aluminum were "found" to be missing at China's Qingdao Port, urging Chinese banks to engage in collateral "quality control" seems like a lost cause.

In fact, the banking regulator itself appears to be in on the joke, because as Bloomberg's Tom Orlik points out, the CBRC requires that collateral accepted by banks must actually exist, as explicitly stated in Chapter 3 on "Risk Mangement" in the just released Collateral Guidelines:

Article 15 The collateral received by a commercial bank shall meet the following basic conditions:

  • the collateral is real;
  • the relationship between the collateral is clear, the mortgage (pledged) has the right to dispose of the collateral;
  • the collateral conforms to the laws and regulations or the national policy requirements;
  • the collateral has a good ability to achieve liquidity.

That's not all.

In a subsequent notice posted in the Securities Times, the Chinese outlet reports that some Chinese rural banks have suspended their interbank businesses including negotiable certificates of deposit (or NCDs) "temporarily" while regulators conduct spot checks. It further adds that at the end of March total interbank liabilities of 25 banks listed in China’s stock market dropped by 1.54t yuan from end-2016, report says, citing Wind Info data, suggesting a sharp contraction in shadow funding.

While it was not immediately clear what the underlying catalyst for the unexpected move was, recall that at the end of March, Deutsche Bank reported that in the most recent troubling trend involving Chinese banks, numerous smaller banks had become acutely reliant on such shadow banking funding mechanism as Certificates of Deposit, which had become the primary source of short-term funding for many of China's banks mid-size and smaller banks.

As DB further explained, the banks most exposed to a shut down in this "shadow funding" pathway are medium-sized and small banks, for whome as of 1H16, wholesale funding made up 31% and 23%, a number that has risen substantially in the interim period.

As Deutsche reflected just over a month ago, "we view banks that are more reliant on CDs as more vulnerable to rising rates and tighter regulations."

Reflecting tighter liquidity, the interbank CD rate has rallied
strongly, with the 6-month CD pricing at 4.6% on average. Some CDs
issued by smaller rural commercial banks have been priced close to 5%
. This would have pushed up the funding cost and notably for
smaller banks. If banks invest in low-risk assets such as mortgages,
discounted bills and treasury bonds, this would lead to a negative
spread. Alternatively, banks can lengthen asset duration, increase the
risk appetite, add leverage or slow down asset growth. Among these
alternatives, we believe a slowdown in asset growth is the most likely

And while it is tangential, here is a list of the banks most exposed to a sudden cardiac arrest involving CDs: INDB, SPDB and PAB are among the most exposed to interbank CDs.

We would not be surprised if these are among the banks that as of this evening have "suspended their interbank businesses."

Which again brings us to the most important question: "Are we close to a “tipping point” in China?" For those who missed the answer the first time, here is Deutsche Bank's conclusion as of mid-March. Note: since then the liquidity situation in China has gotten far more precarious.  Here's Deutsche:

For now, probably not, especially in a year of leadership transition. In our view, the risk of an uncontrollable liquidity event is low, as the PBOC will do whatever it takes to inject liquidity if needed. In the domestic liquidity market, the PBOC exerts strong influence in both the volume and pricing of liquidity. With 90%+ of financial institutions directly or indirectly controlled by the government, PBOC will likely continue to give liquidity support. In 2H15, the central bank established an interest rate corridor to contain interbank rates within a narrow range and pledged to inject unlimited liquidity to support banks with funding needs.



However, continuing liquidity injections do not come without a cost. A bigger asset bubble, persistent capital outflow pressure and a lower yield curve over the longer term are side effects that China will have to bear. At the same time, the execution risk of PBOC itself is rising.

In other words, whether or not China keels over and has a hard (or worse) landing, will depend on the PBOC; when (not if) the central bank gets involved, will depend on how soon China's banks and various CD-funded financial institutions run out of collateral (whether it exists or not) to sell, such as iron ore, copper, precious metals, bonds and even stocks. This will hardly come as a surprise. As we showed last month, the only reason the Chinese banking system hasn't imploded, is due to nearly CNY 10 trillion in central bank liquidity support for the local banks.

One thing, however, is certain: with western central banks refusing to let the market clear on its own, or deflate the $14 trillion liquidity bubble which has suppressed price formation for the past 8 years, the PBOC is merely doing what all of its "civilized" peers have been doing for years - kicking the can, and praying.

Until then, however, things may be about to get a whole lot worse for China's capital and commodity markets.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
booboo's picture

No ticky no tacky

Giant Meteor's picture

No laundry either ..

So much for the cleanest dirty shirt ..

Paul Kersey's picture

Remember before the subprime bust, when Goldman Sachs was using synthetic CDOs as collateral for subprime CDOs? And what kind of collateral do Citi and JP Morgan have for their hundreds of trillions of dollars in derivatives? We were, and still are, living in a global ponzi world.

Juggernaut x2's picture

Oh No -4.6% on a CD- IT'S THE END OF THE WORLD!  That is how distorted the Central Banks have shit-  4.6% is considered a high rate on a marginally risky investment

popeye's picture

Article lost some credibility when suggesting CNY10Trillion = 100% of GDP. Its more like 10%.

SolidAssets's picture

she was a waitress in a cocktail bar now she owns a jet...

ebear's picture

Russian hackers added an extra zero.

Could happen to anyone.

jerry_theking_lawler's picture

The only way the market was pulled back from the edge after 2008 was when the Mark-to-Market rule was ended and Mark-to-Fantasy resumed. Otherwise, the correction would have been to a realistic level which would've been the end of the world banking system as we knew it....

HRClinton's picture

Better find a chair before the music stops. 

Giant Meteor's picture

Regulator Demands That Collateral "Actually Exists"

And no, apparently this is NOT an Onion piece ..

Bloody hell, they're having their 2008-2009 moment ...

And I believe if someone there threatens tanks in the streets, by God they'll get em !

post turtle saver's picture

I'm sorry, but I'm constantly informed by other posters on this site that China is #1 and everything there is fine... this is obviously fake news

Quantum Bunk's picture

China simply produces way more than it consumes. That they deserve credit for.

Giant Meteor's picture

Apparently more than they can offload too ..

Mother of all channel stuffing ..


Giant Meteor's picture

What credit do the masters of disaster get in the USA, for strip mining the nation, dismantling it' industrial infrastructure, piece by piece and re-assembimg "over there" , via labor arbitrage, the search for the bottom, and parody, and the great China miracle ..

I get the fact that they send us lots of stuff we really do not need, to buy on cheap credit, and as we pretend to pay them as well, but just how long was THAT arrangement" suppose to hold out?

I always figured they weren't building those "ghost cities" for shits and giggles .. seems to me they've got a bit of a "leg up" on things .. At the very least, their FEMA camps are going to be a hell of a lot more utiliitarian, as well as attractive ..

The USA, just get's the "ghost malls."

It just ain't right ...


shovelhead's picture


Plenty of credit... In fact they have so much credit they don't even know who owns what because they used it for collateral for more credit.

Giant Meteor's picture

No worries. They'll probably just shoot some folks, backcharge their families for the bullet cost, and all will be swell. You'll see ..

zzzz88's picture

many of you guys misunderstand this issue, it is not over production, not money laundary....

simply put, it is high leverage.

there are no as much financial derivatives in china as here, so they use different way of leverage, 

but we all know, the leverage we used here are much much bigger than china,

so the bubbles in either country bursts, we all go to hell together--no exception

Giant Meteor's picture

Fair enough, over leverage, globally speaking, and yes, we all go to hell together, which you know, we got a preview, already, 

Also, in the matter of "over leverage" , where exactly does fraud, corruption, capital flight, and petro dollars, and lack of demand, come into the picture ..

I mean, doing each other's laundry, near zero prime interest rates, high stakes three card monte, corporate buybacks, seven year car loans, peer to peer subprime lending, inflated luxury real estate (select markets only), trillion $  plus student debt bubble, tapped out consumer credit customers, has been great and all, while it lasted, but it occurs to me, the regular peeps be broke ..

shovelhead's picture

You may go to hell...

I'll go bargain hunting.

Giant Meteor's picture

Well I believe he was speaking you know, metaphorically, mass suffering in general ..

I'm sure he didn't mean you specifically ..

Btw way, I'm having a yard sale next weekend ..

VWAndy's picture

Its a plate spinning contest. With nothing on the plates.

hedgeless_horseman's picture


Our money is on Simon Potter...


...because those are OUR plates he is spinning

Creative_Destruct's picture

Excellent image. Better one: increase number of spinning plates by a factor of 10...or more.

(Many sticks wedged between the poor guys fingers.)

(Then show his feet with balancing sticks between his toes)

Cutter's picture

Kyle Bass recently said in an interview that he was watching the interbank lending closely and that when it froze, devaluation would quickly follow.  Seems like its freezing in some of the smaller banks. 

How long before it spreads?

Giant Meteor's picture

Jesus, if only they hadn't implemented capital controls, 

Ohhhhh Canada, Et tu, Brute?

HobbyFarmer's picture

OK, ZHers.  What happens to bitcoin alt-coin values when interbank lending freezes?

Any predictions before the fireworks begin?

Giant Meteor's picture

Well right off the top of my head, to the moon Alice ?

Cutter's picture

Agree, it will fly.  Until the Government outlaws or tightly regulates it, to stop the hemorrhaging.  Then it will crash.

Giant Meteor's picture

Things will get , "serious." So I was at the local conveinence store, and can't help but notice, everyone flashin their phones at the "cashiers" , and you know, there is an app for that .. but I think, Jesus, almost like overnight, everyone flashin their phones at the cashiers, and you know, I step up with "cash" and it's like, oh, it's you again .. the cash payin guy, I mean what the fuck, don't ya have a phone !? Now, i'll admit, I'm exagerating a bit, but not much ..

Yeah, I can see clearly where THIS shit is headed ..

And you're right, the war, will be on .. bigly

One of We's picture

Are cleptocurrecies and unicorns considered real collateral?  Though rare I assure you I have a nice herd but they are grazing....out there....somewhere.....the unicorns too.....

Giant Meteor's picture

I agree, they can bring that shit to an end in an instant , when they desire,  but in the near to short term before the great blackout, there may be opportunity to leverage for actual useful shit, always a question of timing eh, and musical chairs .


One of We's picture

I had a bitcoin or two but I forgot my password and where the hell I left my "wallet."  I'd sell like crazy right now if I had any I could get to.  Of course I might be really diasappointed next week when they're $2000+/per but the whole falling knife is too stressful for me.  Also, though not optimal, I can wipe my ass with a FRN and they make decent fire starter when dry.....

Giant Meteor's picture

LOL Good show, first belly laugh well actually it''s tommorrow, lol , OK then ...

Really have to retire , read myself to sleep, all be well ..


robertocarlos's picture

Chinese accent: "You pay now"!

bobert727's picture

"as seen by today's plunge in the VIX to a level not seen in 34 years" (1983)

My VIX chart shows a low of 8.6 on December 18, 2006 and 9.31 in December 1993..........

Even if the low on 12/18/2006 was a flash low, the previous day's low was 9.39

TheAntiProgressive's picture

Ruht ro, show me the assets!!!!

Cordeezy's picture

Well China should ask the same of all other countries none of the money reallly exist so at this point what difference does it make?

gdpetti's picture

They probably will, though not so openly, as they seem intent on taking the helm as quietly as possible given their love of "The Art of War".

If they don't directly, it will happen indirectly as all these uncomfortable issues come out of the closet and get exposed.

None of the main players and investors want to face reality, so it will be forced upon them... and this looks like one of those steps.

Wild E Coyote's picture

I have somequestions. Are you telling me that Chinese regulators just woke up and started checking on the collateral? Really? 

Sounds like too late. What if, during the last few years of accelerated debt creation, it was based on BS papers with nothing backing it?

If so, China would be exactly in the same position as ASEAN TIGERS economies in 1998. Did China not learn anything?

The_Passenger's picture

"CNY 10 trillion in central bank liquidity support for the local banks, just under 100% of China's GDP."

Isn't China's GDP something like DOLLAR 11 trillion? That would make the quoted PBOC liquidity support rather 13% of GDP or what am I missing?