Liquidity Risk is Concentrated in Interbank Market: Regulatory Report

A new report on the state of Chinese financial regulation points to the interbank market as the main source of liquidity risk.

The “China Financial Regulatory Report for 2018” (中国金融监管报告2018) said that liquidity risk involves the sudden halt of credit transfers within the financial systems as a whole, and in China at present is primarily concentrated in the interbank sector, in the form of the simultaneous emergence of both an  “asset famine and debt famine.”

The report was released on 12 April, and jointly produced by the National Institute for Finance and Development (国家金融与发展实验室), the China Academy of Social Sciences Financial Research Institute, and the Research Center for Financial Law and Regulation (金融法律与金融监管研究基地).

China’s financial sector remains heavily dominated by state-controlled banks, making the interbank market a core market for the system and liquidity a key variable for gauging its health.

The report said that if bank credit risk continues to accumulate, it will become more difficult to deal with maturity mismatches as well as match assets and liabilities, leading to the simultaneous emergence of an “asset famine and debt famine.”

This could in turn lead to greater difficulty with respect to liquidity management of the banking sector, in turn leading to liquidity risk for the banking system as well as the entire interbank market.

The report forecasts that adjustments to the interbank market will lead to overall tightening of market liquidity, potentially leading to higher interest rates, or moderate sustained increases.

The report also identifies three main sources of systemic risk for the Chinese finance sector:

1.Systemic shocks created by cyclical or structural changes to China’s macro-economy.

2. Endogenous changes within the financial system and the gradual accumulation of risk.

3. Exogenous risk spillovers from outside China’s economic and financial system, primarily form international financial markets.

In order to effectively prevent systemic financial risk, the report advocates a “comprehensive outlook, focusing on the three key missions of servicing the real economy, preventing and controlling financial risk, and deepening financial reforms.”

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