Heightened Regulatory Pressure Could Lead to Consolidation of China’s Banking Sector

Smaller-sized lenders in China are finding it harder to obtain funds via the money market, as liquidity becomes constrained and regulators step up their scrutiny of the banking sector.

According to Reuters the difficulty of obtaining funds via short-term instruments has compelled many smaller Chinese banks to resume the issuance of negotiable certificates of deposit (NCD)’s, a form of financing that has recently come under heavy regulatory pressure due to its categorisation as a shadow banking activity.

This resumption of issuance widened the spread between three-month AAA- and AA-rated NCD’s to a record high of 51 basis points, as smaller, less-creditworthy banks fork out more for much-needed funds.

“What you see there is a reflection of the fact that (smaller banks) are forced to seek more expensive liquidity,” said Alicia Garcia-Herrero, Asia Pacific chief economist at Natixis to Reuters. “No matter how much they chase for new markets, they will always be penalised.”

Chinese regulators have clamped down on interbank certificates of deposit over the past six months, due to concerns that they exacerbate risk by obscuring the eventual destination of funds.

CBRC official Xiao Yuanqi previously indicated in mid-August that the scale of both interbank assets and debts had contracted for the first time since 2010 in the first half, following a protracted period of continuous growth.

As of the end of the second quarter the commercial bank interbank asset balance and interbank debt balance had fallen by 1.8 trillion yuan compared to the first quarter.

Data from Shanghai Clearing House indicates, however that the value of outstanding NCD’s rose by 843.2 billion yuan from June through August, while BNP Paribas senior economist Chi Lo said in a research note that interbank borrowing by small or regional banks had increased to nearly 16% of their total funding sources from 12% in 2015, as compared to around 2% for bigger Chinese lenders.

Regulatory scrutiny of interbank lending is set to further increase in future, with the Chinese central bank declaring in August that the interbank CD’s of banks with assets in excess of 500 billion yuan (USD$ 75.08 billion) will be included in MPA interbank debt ratios starting from the first quarter of 2018.

Should banking regulators opt to include smaller lenders within the purview of this heightened scrutiny, they could put them under even greater pressure, finding it harder to obtain funds via either NCD’s or the money market.

According to Garcia-Herrero the upshot of this heightened pressure might well be the fulfilment of a big picture ambition for financial regulators – the consolidation of China’s banking sector.

“I wouldn’t surprised that you see banks being absorbed by others,” Garcia-Herrero said.

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