Will China Soon Have a 'Lehman Moment'?

With fewer bank deposits, an influx of "quasi-money," and booming "shadow currencies," financial analysts are concerned that the country may be on the brink of a problem. 
Banks in China are taking big risks. (Jon Woo/Reuters)

Money market rates in China climbed again last week, prompting more worries of a deja vu of June’s cash crunch that spooked global markets. That was when the Shibor—the Shanghai interbank offering rate, which tracks the interest rates banks charge each other—soared, reminding many of the Libor leap that happened just before Lehman’s demise in 2008.

The likely cause is that the People’s Bank of China (PBOC) declined to inject funds into the interbank market for a third time in a row Friday. Cash will get even scarcer this week, when banks move cash back onto their balance sheets to meet reserve ratio requirements. For that reason, the PBOC will likely open its tills on Tuesday, soothing the Shibor once again.

The Shibor is useful, says Patrick Chovanec, chief strategist at Silvercrest Asset Management, “because it’s the part of the iceberg that we can see.” Below the surface, however, are far more alarming signs of the state of China’s economy, according to a recent note by Anne Stevenson-Yang of J Capital Research in Beijing. What her research reveals about the source of China’s liquidity suggests that, regardless of China’s 7.8 percent Q3 GDP growth, a Lehman-like bank failure is more likely than ever.

First off, bank deposits, which form the lending base for banks, are growing at a slower and slower clip. That’s largely because the government sets those rates artificially low, households are now shifting funds into high-yield wealth management products (WMPs) and other products that make up China’s shadow finance system—credit channels that exist off bank balance sheets and beyond regulator oversight.

Loan officers are now working overtime to meet quotas for deposits, not loans, says J Capital. When they can, they pass on this work to companies hard-up for credit, requiring them to find depositors willing to put enough of their money in the bank to cover the amount of the loan they need. To lure depositors, the borrowing company offers to pay interest directly to depositors, which supplements the government-mandated 3.5 percent rate the bank pays on deposits. Depositors therefore reap up to 8 percent yield—way higher than the measly 3.5 percent for the deposit. This is so widespread that it’s given rise to a specialist trade in “deposit farming”—i.e. brokering depositor recruitment—which has cropped up on street corners around China, reports J Capital.

​This chart shows the difference between M2, a measure of cash that includes some types of “quasi-money,” and bank deposits.

If deposits are so scarce, how have banks been able to pass the audits at the end of each month, which is when they must meet reserve requirement ratios? By using “quasi-money”—fairly liquid financing instruments that include wealth management products which securitize off-balance-sheet lending, and discounted bank acceptance notes. The latter is a promise of a future payment; businesses can cash them in at a discount before the payment is due. Through repurchase agreements with other banks, they can be wiped off bank books while boosting a bank’s deposits.

Gwynn Guilford is a reporter and editor for Quartz.

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