Counterparty Risk Has Arrived

Following the takeover of Baoshang Bank, the prospect of defaults or haircuts on interbank deposits and payments has dramatically tightened financing conditions for weaker Chinese banks. This is most evident in the low subscription rates for smaller banks’ NCDs, particularly those concentrated in China’s northeastern and southwestern regions. Even though the PBOC has tried to reassure the market that Baoshang’s failure was a one-off event, larger banks have been far more reticent to lend to smaller institutions since the takeover two weeks ago: counterparty solvency risks have arrived in China’s banking system, for the first time in recent history.

In this note we detail the banks that are most dependent upon wholesale funding, and how their ability to maintain access to those interbank liabilities has changed in the two weeks since Baoshang’s takeover. The PBOC will need to provide additional liquidity to these banks to prevent them from reacting to this funding shortfall by redeeming funds placed with non-bank financial institutions (NBFIs), which could cause a sharp selloff in China’s bond markets.

Posted June 10, 2019
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