巴黎银行-中国-信贷策略-中国：信贷风险分化加剧-20190711-14页_1mb

Summary of Document: China – Sharpening credit risk differentiation

Core Content

This document analyzes the implications of the failure of Baoshang Bank on China's financial market and outlines the market and policy responses. It highlights the structural issues within China's banking system, the role of interbank liabilities, and the broader impact on credit risk differentiation and liquidity management.

Main Points

• Baoshang Bank Failure: The first bank failure in China in two decades, triggered by severe credit risks. This event has raised concerns about the stability of the financial sector and the long-standing implicit guarantees that had protected banks from market discipline.

• Market Reaction: The takeover led to a sharp drop in interbank liquidity, with credit spreads widening and NCD issuance declining. Financial institutions became more cautious in their lending and collateral practices, particularly with small commercial banks and non-bank financial institutions (NBFIs).

• Government Response: Authorities acted swiftly to prevent a systemic crisis. They reassured the market that Baoshang was an isolated case, provided liquidity support through various mechanisms, and guaranteed depositors and creditors up to 99.98%, which was much higher than expected.

• Policy Shift: The incident marked a turning point in China's regulatory approach. The PBoC and other regulators have started to implement a risk-based pricing mechanism, which should lead to a healthier and more investable debt market in the long term.

• Credit Risk Differentiation: The failure has prompted a re-evaluation of credit risk across financial institutions. City and rural commercial banks, which have been more prone to risk-taking, are now facing tighter scrutiny and higher funding costs.

• Impact on SMEs: As small banks are the primary lenders to small and medium-sized enterprises (SMEs), the slowdown in credit growth is likely to affect these businesses. The government is expected to push big banks to increase lending to SMEs to mitigate this impact.

• Liquidity Measures: The PBoC injected significant liquidity into the market through open market operations, SLF, and MLF. Additionally, targeted reserve ratio cuts and specific support for small banks and NBFIs helped stabilize the situation.

• Market Implications: The SHIBOR rates have reached their lowest levels since 2010, and the repo market is expected to continue its downward trend. Investors are advised to wait for further policy actions, such as RRR cuts, before reassessing their positions.

• Credit Quality Focus: The event has shifted the market's focus toward credit quality, with a notable divergence in NCD yields based on the creditworthiness of the issuing banks. Pledged repo markets have also seen increased scrutiny of collateral quality.

Key Information

• Financial System Structure: China's banking system is composed of large banks, joint-stock banks, city commercial banks, and rural financial institutions. Small banks have been more reliant on interbank liabilities like NCDs for expansion.

• Interbank Liabilities and NCDs: Negotiable Certificates of Deposit (NCDs) have been a key tool for small banks to expand their balance sheets, often used to invest in interbank wealth management products and other non-standardized credit assets.

• Liquidity Crisis: The Baoshang takeover triggered a liquidity crisis, with NCD issuance falling sharply and credit spreads widening. This led to a re-evaluation of credit risk, with lenders becoming more selective about collateral and counterparties.

• Policy Response: The PBoC and other regulators have taken steps to restore liquidity, including injecting RMB164.4bn in June, targeted RRR cuts, and specific liquidity support for small banks and NBFIs.

• Credit Risk Mitigation: The government has provided a high guarantee ratio for Baoshang's depositors and creditors, which is expected to prevent a broader crisis. However, this also highlights the underlying credit risk in the system.

• Market Outlook: The document suggests that the market is moving in line with the PBoC's goals of reducing funding costs for the real economy. It recommends holding a receiving position in IRS and bonds until further clarity on policy actions is available.

Conclusion

The failure of Baoshang Bank has acted as a catalyst for structural changes in China's financial sector. It has exposed the risks of implicit guarantees and the reliance on interbank liabilities, prompting a shift toward more transparent and risk-based pricing. While the short-term impact has been a liquidity squeeze and increased credit spreads, the authorities' swift response has helped to stabilize the market. The long-term effect is expected to be a more differentiated and resilient financial system, with a greater focus on credit quality and regulatory oversight.