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It is barely an exaggeration to describe the stress in the Chinese interbank lending market as Lehman-esque. Yet the freaking out has been minimal, because observers expect that it's only a matter of time before the People's Bank of China (PBoC) steps in to provide liquidity.
But the lending crisis is in its second week they're still waiting – lending rates remain at levels where no bank can make a profit. Confusion regarding the central bank's intentions continues to intensify.
We can pinpoint the onset of problems to a Chinese government crackdown on fake invoicing . The practice had enabled huge inflows of capital from Hong Kong – estimated at $75-billion (U.S.) between January and April 2013 – to enter the country while being inaccurately described as revenue from exports. When the government stepped in to halt the fake invoicing, liquidity problems followed closely behind.
On June 6, Everbright Bank, a medium-sized lender, unexpectedly failed to repay a short-term loan to a larger bank. This led other banks to become concerned that their peers might be facing similar shortfalls and could default on additional loans; the resulting panic saw rates on seven day interbank loans explode to 8 per cent (annualized) from previous levels between 3.5 and 4.0 per cent.
Two Chinese government bond auctions have failed in the past month for similar reasons. This has happened before – it isn't as big a deal as (God forbid) a failed U.S. Treasury auction. But still, it is indicative of a severe liquidity shortage.
The Chinese government is attempting to alleviate the problem. It recently ordered the country's sovereign wealth fund to buy $500-million (U.S.) in domestic bank shares. The PBoC, however, waited more than a week after the Everbright default to add $15-billion in liquidity to the banking system. Readers would find this even more shocking if they could have seen self-described Hong Kong-based financial professionals on Twitter losing their minds over the initial lack of official response to the emerging crisis.
The PBoC injection helped a bit, but interbank rates remain at extraordinarily high levels (see chart) . I can only speculate that the PBoC is trying to force the banks to adapt to a lower liquidity environment. No one really knows their intentions, and this is possibly the most disturbing factor of all.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB .
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Scott Barlow