PBOC may use new tools to prop up local govt bonds

With an average money cost of 4 percent, commercial banks would lose 500,000 yuan to 2 million yuan for every 100 million yuan bonds they purchase, financial institutions estimated.

The bonds are also considered by banks as not liquid because they cannot be pledged for repos.

Wang Tao, chief China economist with UBS, said:" It is likely in the future that the PSL would be collateralized with local government bonds, or commercial banks may be able to use those bonds as collateral to access "on-lending" liquidity from the central bank.

"Fundamentally, we do not consider this to be materially different from how PBOC has managed China's base money supply in the past. The only difference is that the type of collateral used will now include new bonds once they are available, along with longer terms of liquidity provision," she said.

Wang said the expansion of PSL does not mean that China has run out of other means to increase base money supply, but the government chose to use PSL or other similar liquidity facilities due to a belief that they can deliver more targeted easing to desirable sectors.

Local governments also ramped up their own efforts to increase the appeal of their bonds. Authorities in at least five cities are accepting local-government bonds as collateral, Bloomberg reported on Wednesday, citing people familiar with the matter.

Governments require collateral when they deposit cash at competing commercial banks. Typically, only central government bonds qualify.

The Caixin report also said that officials at bank headquarters are unwilling to buy these bonds, but officials at local branches tried to persuade them out of concern over local governments' deposits, which is a main source of bank deposits.

Two researchers from the Institute of Finance and Banking under the Chinese Academy of Social Sciences said in an academic journal on Wednesday that the circumstance for issuing municipal bonds are far from mature, so the Finance Ministry should consider issuing special State treasuries instead.

Provincial authorities estimated they had 16 trillion yuan of direct debt by the end of 2014, a 47 percent jump from 18 months ago, an official with the ministry said earlier.

Debts falling due this year is estimated at 2.9 trillion yuan, or 4.2 percent of the country's GDP, the China International Capital Corp said in a recent report.

Central bank options

Standing Lending Facility

Introduced in early 2013, this is a regular monetary policy tool to improve liquidity management, meeting financial institutions' large amount of liquidity demand with relatively longer durations.