China’s Bond Rout and the Shadow Market

By | December 19, 2016


Chinese banks have been relying on two sources of credit for liquidity – interbank loans and private loans through the Shadow Banking market. Interbank loans are controlled by bank policies and by the central bank (PBOC). Shadow loans are issued by private creditors. The liquidity crunch over the past week has been blamed by analysts and the media primarily on rising interest rates from the PBOC as it seeks to restrain overall credit, targeted both at excess investment generally and at the property market in particular. This has led to the widespread sale of corporate bonds owned by the banks. According to a senior commercial banker in Beijing, there is a crisis among many financial institutions. “More than 20 securities firms and banks are involved,” the banker noted.

However, the reaction and impact of the private market on bank liquidity has been widely ignored. We think this is a mistake. There is an estimated Rmb30 trillion in private loans sold as investments, called Wealth Management Products (WMPs). These investors are very sensitive to changes in both financial factors (such as interest rates) and the economic decisions coming from Beijing. Any indications of instability could quickly lead to a withdrawal of this source of liquidity from the private sector and a potential credit crisis throughout the economy – affecting banks, personal loans, and corporates that have relied on private credit. The past week has shown an alarming rise in interest rates and a shortening of duration in the WMP market, indicating a high degree of nervousness among private investors. wmp-liquidity