My invaluable assistant Oliver Shang tells me that according to a blog written by a banker at Dongguan City Commercial Bank, a small bank in Guangdong, short term interest rates are getting so high for some of the smaller banks that they are turning to alternative sources of funding to cover the period of deposit withdrawal during big IPOs.
As I have written in earlier entries, big IPOs on the local exchanges are a real problem for the smaller banks, because they tend to be heavily oversubscribed (by as much as 100 times or more) and potential buyers have to deposit the full amount of their order with their brokers, even though they are unlikely to get more than 1-2% of their order filled.As a result money is drawn from banks all over China and deposited with brokers, who then deposit the money in their own bank accounts, which are likely to be the largest banks.The net effect is a drain of deposits from smaller banks, who already rely more heavily than big banks on purchased money to fund their loan book, to larger banks.
In order to keep their funding intact, the small banks enter into the short-term money markets to borrow against the withdrawn deposits, driving money market rates up substantially. The PBoC does attempt partially to accommodate, but they do so mostly by not rolling over maturities due around the IPO dates, and they never do enough to eliminate the cash squeeze.
According to the banker-blogger, repo rates have become so high for the smaller commercial banks that some of these banks, including his own, are unwilling to finance in the repo market, and instead they choose to sell assets, mostly short-term assets, to raise liquidity. The reason they do so is because large IPOs freeze money for at most four or five days, whereas the repo markets have become so tight that as much as two weeks before a big IPO, 14-day, 21-day, and 1-month repo rates all rise substantially. Since the banks do not want to be locked into high-cost funding for so long (especially as large IPOs have become quite frequent) they prefer to raise liquidity by selling short-term paper.This is apparently at least one reason for yields on short-term assets to have become so volatile recently.
Unfortunately for the small banks the market is a learning machine.Repo rates have started rising long before large IPOs because market participants are now used to the liquidity squeeze that precedes them, but as banks turn to selling short-term paper to get around the repo market, the prices of these assets are also dropping earlier and earlier before the IPO date.This means that the small banks are effectively funding at high rates for longer and longer periods.
I believe the next scheduled big IPO is by China Railway Engineering Corporation.Money for purchase orders will be frozen from November 21 to November 23. They expect to issue 3-4 billion shares and may raise RMB 20 billion or more.If past experience is any guide, we may see as much as RMB 2 trillion ($270 billion) or more in orders.
You do not need to worry about the small bank in China now. Given the financial industry in China is still a restricted area, there are tons of money in the line to get in those established banks.
By fatbrick - 11/9/2007 2:50 AM
Prof. Pettis,
If Chinese banks in general are getting squeezed by significantly negative real interest rates on deposits (causing Chinese savers to evacuate savings deposits in favor of the stock market), isn't this an extremely canny way for 1) the Chinese gov't to route money fleeing the banks back into the banking system, despite negative real rates; and 2) large Chinese banks to crush smaller competitors?
These IPOs--PetroChina's at least--seem calculatedly under-issued. I figured it was for headline value (2% of PC stock is valued at $20 billion, so newsies extrapolate that out to a straight line and say, "PETROCHINA IS WORTH $1 TRILLION!!1!), but it seems like a brilliant scheme to have little guys think their money is going into stocks, when 99% of it isn't. The IPO issuer gets preposterous valuations, while the 99% of investor cash that doesn't get invested is effectively vacuumed up by by the large banks at the expense of the little guys.
In other words, a brutal de facto consolidation of the Chinese banking sector is underway.
It would also explain the emergence of 'informal banking' that you mentioned earlier, as there are lots of Chinese who don't want to throw money at the stock market, but are tired of seeing their bank accounts evaporating.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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January, 2008
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