LAST month some Chinese banks found it excruciatingly difficult to borrow the money they required from their fellow banks. The interest rate for an overnight loan from one bank to another briefly hit 30% on June 20th, compared with a typical rate of about 2.5% earlier in the year. This cash crunch or “Shibor shock” (Shibor stands for Shanghai Interbank Offered Rate, a benchmark interest rate) raised immediate fears of bank defaults. It also highlighted broader concerns about financial excesses in China, where the supply of credit has been growing faster than the economy. What caused the sudden cash crunch?
Banks keep cash in reserve both to satisfy regulatory requirements and to meet their obligations to customers, creditors and each other. If a bank runs short of money, it typically borrows cash from other banks that have more than they need. Although banks can run out of money, China cannot. Its central bank, the People’s Bank of China (PBOC), can “print” all the yuan it needs. It transfers this freshly created money to the banks by buying something from them, such as foreign currency, bonds or other safe financial assets. It can also lend it to them. But when China’s banks ran short of cash last month, the central bank surprised everyone by refusing to help. Instead of adding more money to the banking system it sat on its hands, causing the crunch. Exactly why it did so is still in dispute.
A central bank may be reluctant to print money if it fears inflation. But inflation in China is quite low. The PBOC was instead worried about something else. In its public statements, it argued that the banks as a group had plenty of money between them. If one or two of them were running short that was because they were behaving badly. Perhaps they had lent too much, in one form or another. Or perhaps they were taking out a lot of short-term loans from their fellow banks in order to make a lot of longer-term ones. Banks can get away with this kind of overstretch and mismatch if they know they can always borrow easily and cheaply. Perhaps the PBOC wanted to shake their complacency by creating a cash squeeze. But instead it caused an unexpectedly severe crunch. As interest rates spiked, the central bank was slow to react or to clarify its intentions. That allowed fear and uncertainty to spread. Eventually the central bank did intervene, ordering big banks to lend to smaller ones and promising to stabilise the market. But the banks remain shaken by its hesitation.
What will be the lasting consequences for China’s economy? The direct damage will be limited. The shock was sharp but short. Interest rates have fallen a lot (although they remain higher than they were pre-crunch). The stockmarket, which plunged on June 24th and 25th, has risen by more than 7% from its lowest point. But the indirect consequences could be profound. The central bank’s foot-dragging shows that China’s leadership is worried about rapid credit growth. This excess lending is contributing little to the economy. Instead of financing consumer spending or business expansion it appears to be financing the purchase of existing assets instead. That adds nothing to growth. The government’s efforts to curb lending could, however, subtract quite a lot from growth. The director of GK Dragonomics, a consultancy in Beijing, has predicted that China will grow by little more than 6% in 2014 at best. Barclays Capital argues that quarterly growth could briefly fall to 3% at some point in the next few years. Neither outfit is known for its bearishness. China has not run out of money, but its double-digit growth model has run out of steam.