The Hidden Leverage in China’s Money Markets

China’s money markets have exploded with activity over the past year, as banks and other institutions appear to be using leverage to purchase corporate and policy bank bonds despite rising credit risks. Before the Chinese New Year holiday, Chinese regulators started to warn about potential restrictions on this leverage, via limits on funds raised via wealth management products and placed with third parties. These third parties, including securities companies, trust companies, and bank wealth management products themselves, are acting as de facto special purpose vehicles (SPVs) or SIVs for the Chinese banking system, and have dramatically increased their borrowing via the pledged repo market.

The key question is how China’s record pace of asset growth in the banking system (over $4 trillion last year) is currently being funded, particularly in an environment in which China is facing capital outflows and the central bank’s balance sheet is shrinking. PBOC efforts to control short-term interbank rates are feeding this expansion in leverage within the banking system, but the size of direct central bank support remains unclear. Policy measures to attempt to control leverage are necessary, but risk rising corporate borrowing rates and the potential for June 2013-style shocks in China’s money markets.

Posted August 1, 2017
Facebook Twitter Pinterest