Tight liquidity raises bank risks, Fitch says

Persistent tight liquidity conditions in China's financial sector could constrain the ability of some banks to meet upcoming obligations on maturing wealth-management products (WMPs), Fitch Ratings says.

"We estimate that more than 1.5 trillion yuan ($244.5 billion) in WMPs - substitutes for time deposits - will mature in the last 10 days of June," Charlene Chu, Senior Director of Financial Institutions at Fitch, said in a report on Friday.

Issuance of new products, and borrowing from the interbank market, are among the most common sources of repayment for maturing WMPs, and the recent interbank liquidity shortage complicates both.

"China's mid-tier banks, also known as joint-stock, are likely to face the most difficulty, with an average of 20 percent to 30 percent of total deposits in WMPs. This compares with 10 percent to 20 percent for State-owned and city/rural banks," Chu said.

WMP payouts will exert further upward pressure on interbank interest rates, which hit all-time highs on 20 June. The seven-day interbank repurchase rate has averaged close to 7 percent since June 6, more than double the Jan1 to June 5average of about 3.3 percent.

"The recent tightening in liquidity was sparked by a drop in foreign-exchange inflows and seasonal tightness associated with the mid-June holiday; quarter-end prudential requirements; and fiscal deposit submissions. But it has intensified, as the People's Bank of China (PBOC) has largely refrained from intervening.

"State banks are the primary beneficiaries of foreign-exchange inflows, and the drop in these flows is a key reason why recent tightness is being felt even among the largest lenders in the country," she said.

Chu said the Chinese authorities have the ability to address the liquidity pressures, but their hands-off response to date reflects, in part, a new strategy to rein in the growth of shadow finance by constraining the liquidity available to fund new credit extension.

"We expect this approach to be more effective and swift in slowing shadow activity than previous efforts, which have focused predominantly on rules and regulation.

"But such an approach also increases repayment risk among banks, and raises the potential for a policy mis-step and/or unintended consequences," she said.

Fitch said it would expect broad credit growth to decelerate more noticeably for the rest of 2013 should authorities retain this policy stance, following an unprecedentedly active first quarter.

"We project our measure of broad credit to remain on a par with 2011-2012, at more than 18 trillion yuan. But there is significant scope for the reality to be below forecast - should tight liquidity conditions persist or worsen into the second half."

"This credit deceleration will create a further drag on economic growth, which has been slowing down steadily since early 2010," Chu said.