Liquidity Crunch and the Budget Reform Process

CHINA FINANCIAL - Report 29 Mar 2017 by Michael Pettis

Special points to highlight in this issue:

• Early in the week of March 20 the Chinese financial system suffered the latest of a string of temporary liquidity shocks that sent short-term rates soaring and unleashed rumors of smaller banks unable to roll over liabilities that funded highly mismatched balance sheets. The liquidity shock was resolved within days by liquidity extension provided by the PBoC.
• This was simply the latest of a series of similar liquidity shocks we have experienced since June 2013, and even earlier, in which the regulators have taken steps to discourage certain types of risky and credit-eroding behavior among Chinese banks, especially rural and city banks.
• This behavior, however, is not the result of rogue banking or bank mismanagement. It is a systemic problem, the inevitable consequence of irreconcilable pressures that banks face on the one hand from regulators trying to reduce banking fragility and on the other from local authorities determined to achieve GDP growth targets. Until policymakers give up one or the other objective, the Chinese banking system will continue to be wracked by these events.

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