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Jun 18, 2013 | 18:16 GMT

2 mins read

Troubling Interbank Lending Rates in China

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Troubling Interbank Lending Rates in China

A cash crunch over the past three weeks has caused rates on loans between banks to spike to the highest levels since mid-2011. Rates have since subsided, but conditions exist for them to remain elevated over the next month or beyond. The recent spike in interbank lending rates began in late May after a combination of factors caused a liquidity shortage. The monthly average overnight rate stood at 2.9 percent in April but rose to 6.4 percent in May.

A similar confluence of issues led to a spike in interbank lending rates during roughly the same period in 2011. But this time around the consequences have raised greater fears. On June 6, China Everbright Bank, the country's 11th-largest lender, defaulted on a 6 billion-yuan (roughly $980 million) loan repayment to Industrial Bank Co. The default allegedly caused Industrial Bank Co. to default in turn, and various news reports have suggested that other banks also may have defaulted on loans, though this is unconfirmed. On June 7, the central bank allowed more cash to flow into the interbank market as previously scheduled, providing some relief for strained banks, though it did not take any additional action. Recent reports suggest that the "Big Four" state-owned banks are lobbying the central bank to ease policy and avert further deterioration.

These recent events point to the rising financial trouble in China, where debt levels have rapidly grown as a result of the investment-driven economic model and the post-financial crisis drop in export growth, which has forced the country to rely almost wholly on investment over the past four years. Bank failures are rare since state entities step in quietly to prevent panic and ensure stability. The new administration will do the same, even at the risk of weakening its commitment to reform. But if more bank defaults occur and the central bank refuses to provide support, or if the central bank eases its clampdown on credit growth and bank troubles continue unabated, then authorities could soon find themselves overwhelmed.

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