The failure of Baoshang is challenging the Chinese interbank market as fears of contagion grow

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SHANGHAI (Reuters) – Almost three weeks after Chinese regulators took over troubled Baoshang Bank, a mid-sized investment fund house in Beijing suddenly couldn’t borrow cash on the interbank market and defaulted on some products.

FILE PHOTO: A man walks past a building with an advertisement for Baoshang Bank in Beijing, China on Sept. 8, 2018. REUTERS / Stringer / File Photo

Around the same time, Great Wall West China Bank, a regional lender in Sichuan Province, wanted to sell tradable certificates of deposit (NCDs) – usually a routine fundraising tool for small lenders – but was only able to raise a tenth of the intended amount.

Both examples illustrate the growing distrust of the Chinese interbank market as smaller banks, asset managers and brokers question their creditworthiness after the takeover of Baoshang in Inner Mongolia.

Fund managers and traders are concerned about the prospect of further defaults on interbank borrowing and other banks that have come to light.

“As the old saying goes, if you see a cockroach, you will spot a swarm of them,” said Liu Haiying, founder of Shanghai-based Haiying Investment and author of China’s Huge Debts.

“Worryingly, the Baoshang Bank is likely the first cockroach.”

Particularly shocking to the market was the government’s decision to guarantee only the principal amount for interbank deposits at Baoshang worth 50 million yuan ($ 7.3 million) or less, reflecting the widespread belief in full government guarantees on such assets shocked.

Short-term interbank lending rates rose from a normal level of around 3.5% to up to 15% this month.

“The liquidity stress we are now experiencing is rooted in concerns about bankruptcy, which is very difficult to manage,” said Liu, adding that while authorities were right to try to solve problems, they risked chaos in the financial system cause.

Many small lenders rely on short-term loans for long-term investments, and rising financing costs could affect their returns or force them to liquidate assets. This, in turn, could put a further strain on liquidity conditions in a market that is also an important fundraising channel for smaller fund houses and brokerage firms.

FUNDING FROM WOES

Beijing-based fund house New China Fund Management told clients on June 12 that it was forced to sell assets after multiple products failed, according to a letter sent by Reuters.

When asked about the content of the letter, the fund house said in a statement sent by email that it was “obliged to take active measures to identify and reduce risks”. It has not publicly disclosed the amount of the default or the repayments.

The New China Fund, controlled by Hengtai Securities Co Ltd, was ranked 62nd in terms of assets among 124 Chinese mutual funds as of March 31, according to fund consultancy Z-Ben Advisors.

The Great Wall West China Bank, which has an investment grade credit rating of AA, attempted to raise 500 million yuan ($ 73 million), according to an interbank market statement. It offered a 3.9% return on annual deposits, over the 3.25% offered by issuers of NCDs with world-class AAA + ratings.

An official with the capital markets division of Great Wall West China said the lender had taken emergency measures and was not suffering from a lack of liquidity.

It isn’t the only lender who is disappointed.

Estimates by CITIC Securities showed that issuers of NCDs with a secondary investment rating of AA + or lower increased an average of only 15% of their fundraising goals this month, compared to over 70% prior to the Baoshang Bank acquisition in May.

Wang Ming, a product overseer in the trading division of Hua Chuang Securities, said investors are thoroughly reassessing counterparty risk and demanding higher quality collateral.

“In the past, interbank lending was child’s play. But now it has become very difficult to borrow money when pledging securities rated AA + or below. “

The Chinese Banking Association declined to comment.

Regulators said the Baoshang acquisition was necessary to stave off risk to the financial system and tried to limit the impact, urging larger lenders not to starve smaller players on cash. The central bank has also pumped money into the market.

Over the past week, the central bank and securities commission held meetings with brokers and mutual funds urging them to support one another rather than blindly blacklisting counterparties.

At one such meeting, regulators put it bluntly: “If mutual distrust continues, it will eventually turn into systemic financial risk,” according to a minutes of the meeting that Reuters saw.

The China Securities Regulatory Commission did not respond to a Reuters request for comment.

For many China experts, the Baoshang takeover is the first attempt in Beijing’s new campaign to reduce excessive debt in the banking system and curb reckless interbank lending. It follows a series of deleveraging measures between 2016 and 2018 that targeted the shadow banking sector and off-balance sheet investments.

They also see Beijing’s move as a forerunner to consolidation in an industry with more than 4,000 players and where smaller lenders make up a quarter of the sector’s assets.

Many of these smaller banks have aggressively expanded using cash raised through NCDs. The proceeds flow into riskier but more profitable investments such as corporate bonds or even favorite government projects.

($ 1 = 6.8494 Chinese yuan)

Reporting by Samuel Shen and John Ruwitch in Shanghai; Editing by Vidya Ranganathan and Edwina Gibbs

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