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In a move signaling its perception of the recent abrupt spike in short-term borrowing costs as a transitory disruption, the People’s Bank of China (PBOC) withdrew 109 billion yuan ($14.9 billion) from the financial system on Wednesday. The PBOC accomplished this by providing a smaller amount of new short-term loans compared to the maturing ones.
The withdrawal of liquidity occurred despite recent tight funding conditions attributed to month-end demand, tax payments, and significant government bond sales. Nevertheless, the overnight rate surged to as high as 50% in isolated transactions on Tuesday, causing concerns about potential stress within the financial system.
Bruce Pang, Chief Economist for Greater China at Jones Lang LaSalle Inc., expressed the view that the PBOC likely regarded Tuesday’s incident as a temporary mismatch rather than a structural issue. He noted that the central bank may still reduce banks’ reserve requirement ratio within three months, possibly as early as November, to provide liquidity support for upcoming bond issuance.
The weighted average rate of overnight repurchase agreements, a key measure of interbank borrowing costs, experienced a decline of as much as 15 basis points on Wednesday, suggesting a reduction in liquidity stress. This followed an increase of 18 basis points on Tuesday, the most significant rise since September 28, according to Bloomberg-compiled data.
Funding conditions relaxed on Wednesday as major banks increased cash availability for borrowing, particularly for other banks. Non-banking firms incurred slightly higher borrowing costs.
The PBOC typically withdraws cash from the financial system through its daily open-market operations at the beginning of each month when liquidity conditions tend to ease due to reduced financing demand. Towards the end of the month, the central bank often injects cash on a net basis to assist banks in meeting regulatory requirements.
State broadcaster China Central Television attributed the market disruption on Tuesday to unidentified financial institutions. These institutions were criticized for relying excessively on rolling-over financing, borrowing short-term funds and investing in longer-term assets, thereby creating their own liquidity risks.
The surge in overnight borrowing costs was primarily observed in over-the-counter borrowing by non-bank entities. However, such transactions are not publicly reported.
China’s financial system has faced strain in recent months as the government has sought to stimulate the economy with debt-fueled measures, drawing scrutiny to its money market operations.
Liquidity is expected to tighten following Beijing’s announcement that it would increase the fiscal deficit ratio and authorize the sale of 1 trillion yuan in debt during the remaining months of the year.
Frances Cheung, a rates strategist at Oversea-Chinese Banking Corp., suggested that the PBOC may not aim to address brief liquidity tightness among certain market participants. Instead, the central bank is expected to inject liquidity to accommodate broader liquidity demand arising from bond issuances.
A source close to the central bank indicated that money market rates were likely to return to levels used in the PBOC’s open market operations from Wednesday. The source added that liquidity in the banking system remains relatively abundant.
The PBOC initiated reserve requirement ratio (RRR) cuts in March and September, each by 25 basis points, while also making moderate reductions to the rate of the medium-term lending facility in June and August to support the slowing economy. The central bank intensified cash injections in October amid rising funding costs.
In the coming weeks, 850 billion yuan worth of medium-term lending facility (MLF) funds are set to mature, providing an additional reason for the PBOC to boost liquidity support. Some economists anticipate a 25-basis-point RRR cut by the PBOC within the next two weeks, coinciding with a significant bond sale.
Zhaopeng Xing, Senior China Strategist at Australia & New Zealand Banking Group, remarked that the net withdrawal at the start of the month aligns with tradition, emphasizing the PBOC’s intention to maintain overnight rates at a reasonable level, consistent with its approach since October.
