Small banks feel the pinch of rising borrowing costs

Smaller banks are experiencing record high borrowing costs to raise funds as they are caught between seasonal cash squeeze and the official deleveraging drive.

Issuance of negotiable certificates of deposit or NCDs, an interbank financing tool, jumped to 758 billion yuan in the third week of this month, the most since the securities were introduced in 2013 as a lifeline for smaller banks.

According to Bloomberg data, the yield on one-month AAA-rated NCDs has surged nearly one percentage point in June to all-time high of 5.05 percent, while that on AA+ contracts reached 5.3 percent.

The increase in NCD costs comes at a tough time for Chinese lenders that are facing an unprecedented 4.5 trillion yuan of maturities this April-June quarter.

The pressure has been aggravated by the deleveraging drive, with the one-month Shanghai Interbank Offered Rate climbing for 22 days in a row to a two-year high.

The certificates are used mainly by smaller lenders－banks outside of China's top 10 by market value accounted for 76 percent of total NCD sales this year.

"The smaller banks have no choice but to take the blow," said Shan Kun, Shanghai-based head of China markets strategy at BNP Paribas (China) Ltd.

"They need to sell NCDs to get financing as they cut leverage gradually and as they have to cope with tighter liquidity this month. The rates will likely continue to climb, or at least stay elevated in the near term," said Shan.

When cash supply tightens, small and medium-sized lenders are usually among the hardest-hit because they lack the retail deposit arsenal of larger banks, said Yulia Wan, a Shanghai-based banking analyst at Moody's Investors Service.

They also may not have enough bonds to use as collateral to borrow money in the repo market. The banks need the money to finance longer-term and less liquid assets, such as debt and investment in loans and receivables, she said.

The People's Bank of China has begun to take note of the stress on the financial system.

China's central bank has injected a net 160 billion yuan through open market operations last week, the most since the five days through May 19.

The central bank-run Financial News said on June 10 that the "abnormal market swings" of June 2013 won't happen again－a reference to a record cash crunch four years ago.

Still, China's seven-day repurchase rate, which is the money-market benchmark, has averaged 2.74 percent so far this year, compared with 2.32 percent last year.

Yao Yudong, chief economist with Dacheng Fund and former head of the Research Institute of Finance and Banking of the PBOC, said that the days of wide margins and easy financing for banks are over.

"For lenders, it's not winter. It's just turning from golden age to silver age. Smaller banks should actively expand retail banking and interbank businesses," said Yao.

CHINA DAILY-BLOOMBERG