Credit squeeze tremors rock Chinese banks

China's banking sector is bracing for the likelihood that access to credit will remain uncomfortably tight.

That comes despite signs of central bank intervention to ease the situation and prevent the credit squeeze from spiralling out of control.

Key short-term interbank lending rates fell sharply on Friday from unprecedented highs, prompting speculation that the People's Bank of China had been forced to inject cash into its banking system. Reuters reported sources saying the central bank was encouraging major state banks to resume lending to each other.

But at the time of writing, the PBOC had yet to make any public comment, despite rumours sweeping through the industry.

"If they are doing anything out of the ordinary, they aren't doing it publicly," Carlo Reiter, an analyst at J Capital Research in Beijing said.

State-run Shanghai Securities News took the unusual step of denying talk that the central bank had flooded the market with 400 billion yuan ($70.6 billion) of capital, or that it had bailed the Industrial and Commercial Bank of China out with 50 billion yuan.

"Information is flying everywhere, the financial market is becoming harder and harder to read," the article said.

The Bank of China, a leading commercial bank, was also forced to deny a report in respected business publication 21st Century Business Herald claiming it was effectively in default on Thursday and had to defer transactions for half an hour due to a fund shortage.

In a post on its official microblog, the bank said the rumours were "seriously unfounded" and had malicious intent. It said it had never had monetary defaults and had completed all outbound payments on Thursday.

Interbank lending rates spiked this week as the monetary authority refrained from using open-market operations to address a cash crunch in the world's second-largest economy, seen as a tactic to curb over-exuberant lending practices, particularly in the so-called shadow banking sector. Cheap credit is increasingly seen as a hindrance to achieving more sustainable growth.

The seven-day repurchase agreement rate, a benchmark for interbank borrowing costs, dropped to 8.33 per cent on a weighted-average basis, down from 11.62 per cent at Thursday's close. The overnight repo rate also fell a whopping 352 basis points to 8.22 per cent from the previous day.

"The worst is over; the PBOC is likely to serve as a last resort and intervene to calm the markets and avoid such huge volatility," said Chen Qi, a UBS strategist.

But market analysts said the interbank rates were likely to remain elevated at above 8 per cent for at least the next few weeks, an unprecedented situation.

Financing costs for local governments and private companies would become particularly strained if the credit squeeze persists.

"If the liquidity squeeze worsens and the interbank rate stays at such high levels for longer than expected, that will lead to higher borrowing costs for companies," said Tang Jianwei, an economist at Bank of Communications Co in Shanghai. "It will be devastating to an economy that's already struggling."

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