Tough new bank rules to stabilise money rates

SHANGHAI: A further step in China's banking reforms to manage loan-to-deposit ratios on a daily basis may push banks to balance lending more evenly and help stabilise money market liquidity and rates in the long run.

A monetary tightening campaign in place since October to prevent asset bubbles and control hot money has caused money market rates to swing wildly, sparking concerns over the health of China's banking system and the sustainability of its growth.

To avoid aggravating temporary cash shortfalls as banks rush to meet month-end loan-to-deposit requirements and payments for reserve requirement ratio (RRR) hikes, the authorities want to shift to a daily rather than monthly monitoring system for the loan-to-deposit ratios.

This comes on top of a series of bank reserve ratio hikes and interest rate rises to curtail excessive liquidity and manage inflation -- tough medicine to avoid a full blown bursting of China's asset markets.

The China Banking Regulatory Commission (CBRC) plans to soon order banks to maintain loan-to-deposit ratios not exceeding 75 percent on a daily instead of monthly basis, traders say.

State media had said the changes may have been put into place this week but traders and bankers say the banking regulator has yet to officially kick off the process.

"It may be because of technical barriers, including the difficulty to quickly establish mechanisms to monitor banks' loan-to-deposit ratios on a daily basis," said a senior trader at a major Chinese commercial bank in Shanghai.

"But we are certain that the reform is on the way."

Last December, China's benchmark money market rate, the weighted average seven-day government bond repurchase rate , saw its second most volatile month ever under the double whammy of meeting quarterly loan-to-deposit ratio rules and fears of tightening steps by China's central bank.

The most volatile month was in October 2007 due to a slew of super-large initial public offerings that regulators pushed into the equity market to help cool a stock fever. That boosted the Shanghai share index to a record high at the time. Stock prices have since plunged from the weight of a much needed technical correction and fears of further government policy tightening to fight high inflation.

Regulators had switched from a quarterly loan-to-deposit ratio system to a monthly one at the start of this year to cool money market volatility. But the situation appears not to have significantly improved as month-end demand collides with other factors.

The seven-day repo rate jumped 250 basis points over a span of two weeks in late May partly because banks borrowed money to meet month-end loan-to-deposit ratios.

The cash call, coupled with companies rushing to meet their operational income tax for last year before the end of May, worsened a crunch sparked by the People's Bank of China's hike in RRR, which froze 370 billion yuan ($57 billion) in mid-May.

"The change to a daily loan-to-deposit ratio monitoring system will help ease spikes of money market rates at the end of the month by balancing banks' lending behaviour," said Wang Haoyu, economist at First Capital Securities in Shenzhen.

"However, it will take at least five or six months for regulators to get mechanisms ready to monitor banks' daily average loan-to-deposit ratios, so money market volatility may persist for a while."

The move will put pressure on banks to absorb more capital and force them to promote longer-term financial products promising higher returns to enlarge their deposit bases.

In the long run, it will change the prevailing practice whereby banks lend as much as possible early in the month and hoard or collect cash at month-end to meet the loan-to-deposit requirements.

"There will be a stabler pace of lending for banks, easing a typical month-end liquidity shortage on the money market," said a dealer at a major Chinese state-owned bank in Beijing.

To cushion sharp fluctuations in money market rates, which have hurt corporate short-term funding needs, the PBOC has been injecting cash into the market via its maturing bills and bond repurchase agreements.

This week, the PBOC is on course to inject 81 billion yuan into the banking system through moderate open market operations

to help stabilise money market rates after it injected 181 billion yuan in May and another 280 billion yuan in April.

Copyright Reuters, 2011