China's banking regulator ordered some of the nation's smaller lenders to set aside more funds to avoid a cash shortfall, three people with knowledge of the matter said, signaling rising concern that defaults may climb.

China Banking Regulatory Commission (CBRC) branches asked some city commercial banks and rural lenders to strengthen liquidity management this year, the people said, asking not to be identified because the matter is confidential. Different requirements are being instituted by province, such as quarterly stress tests, after CBRC studies last year showed increasing risks at those lenders, the people said.

The People's Bank of China (PBOC) signaled on Feb. 8 that volatility in money-market interest rates will persist, underscoring investors' concerns that financial stresses could drag down growth in the world's second-biggest economy. The bailout of a 3 billion-yuan ($495 million) high-yield investment product days before it matured last month highlighted challenges for authorities seeking to rein in an unprecedented credit boom.

“Smaller banks are the weakest link of China's financial system because their lack of a stable deposit base would force them to seek more expensive funding and offer more risky loans,” said Liu Jun, a Wuhan-based analyst at Changjiang Securities Co. “They will be hardest hit when borrowing costs are elevated and the economy slows.”

The requirements add to steps taken to protect against soured loans weighing on China's economy, which included speeding up bad-loan write-offs and limiting local government debt sales.

The benchmark seven-day repo rate, a gauge of interbank funding availability, surged to a record 10.77 percent on June 20 as institutions struggled to obtain funds amid a PBOC crackdown on shadow finance and more than doubled in December to 8.84 percent as lenders hoarded cash to meet year-end regulatory requirements. It was fixed at 5.3 percent yesterday.

Some of the banks were asked by their local CBRC branches to set aside reserves to ensure cash supply for 30- to 45-day periods, the people said, declining to identify the banks. Press officers at the CBRC's headquarters in Beijing didn't return three calls seeking comment yesterday.

'Decisive' Role

China's money markets are playing a greater role in credit allocation and borrowing costs as the central bank has moved to liberalize interest rates and make the economy less reliant on banks for funding. The PBOC abolished controls on bank lending rates in July, and the Communist Party said in November it wanted markets to play a “decisive” role in pricing capital.

“When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that,” the central bank said in a Feb. 8 report. “The market needs to tolerate reasonable rate changes so that rates can be effective in allocating resources and modifying the behavior of market players.”

One or two small Chinese banks may fail this year as they get about 80 percent of their funding from interbank markets and higher-cost deposits in savings vehicles known as wealth management products, Fang Xinghai, a bureau director at the Office of the Central Leading Group for Financial and Economic Affairs, said in November. The group is the highest-level agency within the Communist Party for financial and economic policies.

China's five biggest state-owned banks and 12 national lenders controlled more than 60 percent of the nation's 148 trillion yuan of banking assets at the end of 2013, according to CBRC data. Other financial institutions including 144 city commercial lenders, 337 rural banks, and more than 1,900 rural cooperatives owned the rest.

Instant Insights /

Banks in China Told to Set Aside More Funds

Related Stories

Recommended For You