Counterparty risks are being looked at in a completely different light by Chinese bond traders following the seizure of Baoshang Bank Co. by the Chinese government. Traders are rightfully unwilling to touch even premier, AAA rated bank short-term bank debt as security due to the seizure of the bank last month.
Corporate bonds that do not have Chinese sovereign bills or policy bank notes as pledges simply aren’t being considered. This is, in turn, causing China’s financial institutions to become mired in problems with funding being clogged up and has already caused borrowing costs to massively spike for brokerages and smaller banks.
Bad timing of seizure could lead to increased defaults
The timing of these problems is particularly bad due to lowered liquidity in the current market, with higher defaults being a very real possibility if any more ramifications come from the Baoshang Bank Co. Seizure.
David Qu, who is an analyst at Bloomberg Economics and is based in Hong Kong, says that the biggest buyers of corporate bonds in China are actually non-bank financial institutions. If the funding chain for these non-bank financial institutions breaks, this will hurt them a lot, particularly those who are not able to pledge for borrowing. Weaker companies will get hurt by the rising cost of selling new bonds and this will lead to much higher default numbers.
One trader at a Beijing brokerage, who asked to remain anonymous, said that the brokerage’s counterparty has just tightened the screws on collateral for repo lending. Whereas earlier AA+ debt was acceptable, now it is only willing to accept AAA debt, and even then it has to be in the form of negotiable certificates of deposits. Other traders in the industry have been saying that many counterparties are now only accepting government bonds as collateral and this is hurting bond trading.
Liquidity in the financial market could be hurt long term
China has a very specific way of funding. Large national banks lend to smaller regional banks. These smaller regional lenders then provide financing services to brokerages and funds. Those, in turn, use the money they borrowed to invest in corporate bonds and in effect keep the wheel of the economy spinning.
According to Ming Ming, who is the chief fixed-income analyst at Citic Securities Co., the smaller banks in China play a crucial role in this process and with investors feeling increasingly risk-averse and wanting to mitigate counter-party risk this could lead to some bank times for China’s financial system. It could, in fact, lead to a complete collapse of the liquidity of the Chinese financial market which would have impacts far beyond its own borders.
Authorities int he country have held talks with brokerages to discuss the risks that are clearly present to liquidity in the market currently. The seven-day and 14-day repo rates soared to an excessive 15% – far too high according to many traders in the industry. The key problem is that despite the central bank having injected liquidity into the market, it has only really benefitted big banks and not the smaller ones.