Chinese banks face worsening short-term liquidity

A steady fall in foreign direct investments are crimping the expansion of China’s monetary base.

The latest signs of a marked economic slowdown saw market rates increase last week as banks' ability to handle short-term liquidity crunches weakened further.

Money market cash flows tightened at the beginning of last week as payments for a large number of bond issues came due, traders said. Banks also needed extra funds because they are required to adjust their reserves on the 5th, 15th and 25th in line with the rise or fall in their deposits to meet the required reserve ratio ordered by the People’s Bank of China, the central bank.

Some traders said even large banks are having to borrow given short-term liquidity crunches, a clear sign that the supply of long-term base money in the system is really shaky.

Traders have been predicting an imminent RRR cut since late June and expected it or an interest rate cut to occur last week. PBOC, however, has refrained from doing so and instead has resorted to short-term reverse repos to handle temporary liquidity shortfalls.

Purchase of foreign exchange is the primary way for China to expand its monetary base. The central bank, however, favors using reverse repos to achieve the same effect.

The Ministry of Commerce said FDI inflows dropped 3.6% from January to July from a year earlier, extending the longest series of declines since the last global financial crisis. China drew-in US$66.7 billion in FDI between January and July. July's FDI was US$7.6 billion, down 8.7% year-on-year.

This slowing down in capital inflows has greatly weakened the expansion of the monetary base, subsequently wearing down base long-term liquidity that had accumulated in the banking system, said one trader at a major Chinese state-owned bank.

"With the central bank refusing to inject long-term funds into the system, banks have found themselves increasingly challenged to handle sudden surges of liquidity demand."