China regulators probe liquidity stress that sent rates to record 50%

SHANGHAI  -China’s financial regulators are investigating a month-end liquidity crunch that saw short-term money rates surge to as much as 50 percent, asking some institutions to explain why they borrowed at extremely high rates, three sources said.

The overnight rate for pledged repo – a short-term financing business – hit a record high of 50 percent on Oct 31, as a month-end scramble for cash and a flood of government bond sales caused stress in money markets.

The China Foreign Exchange Trade System (CFETS), a central bank affiliate that operates China’s interbank market, has asked institutions that settled trades on Tuesday at the 50 percent rate to submit explanations, according two sources with direct knowledge.

“Anyone who borrowed money at very high rates need to explain to regulators the decision-making and bidding process,” said another direct source.

Traders and analysts said an increasing supply of government bonds, and newly approved 1-trillion-yuan ($136.63 billion) sovereign bond issue created unusual liquidity stress at a time when banks need to square their books to meet month-end regulatory requirements.

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Authorities also could have wanted to keep yuan liquidity tight to stem the currency’s slide against the U.S. dollar in the foreign exchange market, Becky Liu, head of China macro strategy at Standard Chartered said.

A trader said a large number of fund houses, brokerages and trust firms were scrambling to borrow money in afternoon trade on Tuesday to avoid defaults as big banks appeared reluctant to lend.

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“Demand for cash far exceeded supply, boosting short-term rates,” the source said. “For each individual institution, it was a rational decision.”

But regulators on Wednesday told some institutions in a meeting “not to be emotional,” another trader source said.

“Everyone is still slightly nervous now. Everyone is prepared and will keep the liquidity ample.”

($1 = 7.3188 Chinese yuan renminbi)