Liu Jun：Why Sentiment Wields an Outsized Influence in China’s Markets

2019-07-28 IMI

This article first appeared in Financial Times on July 17, 2019. Liu Jun, Member of IMI Academic Committee, Vice President, China Investment Corporation Everyone is talking about liquidity. From the stock market crash in the last quarter of 2018, to the recent turmoil triggered by the freezing of redemptions on a fund run by Neil Woodford, a star UK stock picker, investors are worrying about the risks of not getting their money back. Similar fears are testing nerves in China’s interbank market, the main financing platform for financial institutions. The event that sparked panic was the announcement on May24 that the People’s Bank of China was seizing Baoshang Bank, an Inner Mongolia-based lender, amid credit risk concerns. The idiosyncratic problems faced by a little-known regional bank unexpectedly drove the overnight lending rate up by dozens of basis points, and the issuance of negotiable certificates of deposit — short-term liquid debt instruments — by second and third-tier banks came to a near halt. The incident harks back to the liquidity shock of June 5 2013, when social media spread misleading information about a lending dispute between two banks. Panic followed a relatively normal late-payment transaction and the term qianhuang, or “money famine”, was coined. The ensuing liquidity crunch lasted more than three months and pushed up the overnight rate to apeak of more than 10 per cent. There are multiple possible explanations forsuch an extreme reaction. The first plausible cause would be if the supply of macroeconomic liquidity had fallen below a viable minimum. But this was not the case: PBoC data on the Aggregate Financing to the Real Economy — the volume of funds provided to the private sector by China’s domestic financial system — show annual growth rates in double digits. Though the rate has fallen from a high of about 50 per cent in 2004 to a low of 11.2 per cent in 2019 it is still ample to support GDP year-on-year growth — which declined to 6.2 per cent in the second quarter of this year, according to figures released on Monday. A second possible explanation might be a collapse of market liquidity via a significant change in the interbank supply-demand relationship a market that represents the overwhelming majority of the institutional financing activities. Yet here, too, there has been no significant disruption. The dominant suppliers of liquidity are the commercial banks. In particular China’s Big Four — Bank of China, China Construction Bank, Agricultural Bank of China and Industrial and Commercial Bank of China — use their vast branch networks to suck up huge supplies of customer deposits. On the receiving side are hundreds of banks: joint-stock lenders city commercial and rural commercial banks and co-operatives. As the big banks turn on the tap the smaller ones are flooded with liquidity. And most individual savings still end up with the big banks, despite a behavioural shift among younger investors. But the third explanation is potentially the most powerful. This centres on changes in what might be termed psychological liquidity and relates to market participants perception of factors ranging from the real supply-demand dynamic to the herd effect of market panic. Investors often overreact to negative events such as the Baoshang case — the subsequent psychological liquidity freeze can thus lead to a very real liquidity squeeze in the marketplace. All developed economies exhibit these three dimensions of liquidity. But in China, the psychological element exerts outsized influence. The root cause lies in China’s system of indirect financing. Total bank assets amount to about Rmb270tn ($39tn) compared with just Rmb30tn ($4.4tn) for other financial institutions, according to the latest data. The commercial banks clearly determine whether liquidity is tight, neutral or loose. Given that they share the same business mix and have a similar blend of commercial shareholders with substantial state-owned stakes, their operating models and risk appetites are similar too. The systemic homogeneity naturally leads to parallel market behaviours — as dominant operators in the market, with no countervailing forces, it is easy to see how negative events can be over-interpreted. A restructuring of China’s financial system is imperative if its liquidity challenges are to be addressed. First, market financing facilities in equity and debt should be promoted in order to wean the economy off an overdependence on bank lending. A second natural priority should be the development of a multi-layered capital market to satisfy the various financing needs of companies at various stages in their life-cycles. Until then, market participants need to be well diversified to avoid the one-way lurches that result from the current structure of financing.

DOWNLOAD

Liu Jun：Why Sentiment Wields an Outsized Influence in China’s Markets

related articles

tags