On Sunday, securities regulators summoned a group of large Chinese brokerages and asset-management firms to a closed-door meeting in Beijing and asked them not to cut off trading and other dealings with smaller banks and financial institutions, according to a meeting summary circulated among industry participants Monday.
The memo said there had been some defaults in the repo—or repurchase agreement—market, where banks, brokers and other financial firms borrow cash for short periods by pledging securities against short-term loans.
It said some institutions in the debt markets had placed certain trading counterparties on a “blacklist” and demanded they post higher-quality collateral against their borrowings. In other instances, some firms were cut off from trading because of worries that they would not repay their obligations, it said.
“If such mistrust is allowed to continue to spread, it will eventually become systemic financial risk,” the memo said, adding that mutual funds and brokers need to provide liquidity support to each other. It also said the China Securities Regulatory Commission and People’s Bank of China are closely monitoring the situation.
Chinese authorities are trying to contain the market fallout from their seizure of Baoshang Bank Co., a bank based in Inner Mongolia, on May 24. The commercial bank had been controlled by a missing Chinese financier.
Following the takeover, interbank lending rates in the country climbed, as did yields on lower-rated negotiable certificates of deposits—a common tool used by smaller banks to raise short-term funding. Issuance of these CDs also dropped, indicating that buyers of the debt have become more risk-averse and worried about defaults.
Banking authorities have stepped in to protect the interests of Baoshang’s individual depositors and are guaranteeing the bulk of its liabilities to companies and financial institutions.
China’s central bank has sought to assure the market that the Baoshang takeover was an isolated incident and ease banks’ funding strains.
Last Friday, it provided 300 billion yuan in additional liquidity support for small and midsize banks through lending facilities that institutions can tap by pledging bonds and other debt as collateral.
The central bank last week also said it would provide a financial backstop for CDs issued by Bank of Jinzhou, another midsize commercial lender. The Hong Kong-listed Chinese bank on May 31 disclosed that its auditor, Ernst & Young, had resigned, causing prices of its U.S. dollar bonds to plunge. It has since replaced the firm.
On Sunday, the People’s Bank of China said that even though a small percentage of Baoshang’s clients didn’t receive a full guarantee on what they are owed, the takeover has helped prevent systemic financial risks and maintain social stability.
If regulators had provided a 100% guarantee on all the bank’s liabilities, that would have used up a lot of public funds, the central bank said. That could lead to a moral hazard problem, it said, which could “encourage the market to act aggressively.”