Why China's liquidity crunch was a 'self-engineered crisis'

Analyst said the central bank may have played a role.

According to OCBC, the spike of interbank rate in June is not rare in history; however, the level of tightness is unusual.

It was mainly due to the combination of regular factors and ad hoc factors (slowdown in capital inflows and PBoC’s inaction).

Here's more from OCBC:

In some ways, the liquidity crunch was a self-engineered crisis by China’s central bank.

We estimated interbank on balance sheet net claims on other depository corporation rose significantly by CNY2tn after excluding the amount of financial bond issuance in the first five months of 2013.

This rapid expansion in interbank claims is one of the key triggers for PBoC’s inaction.

Ever since PBoC released its statement on 25 June, the interbank borrowing costs have fallen significantly. We believe the systemic risk is remote due to three reasons (20% RRR, China’s low LDR ratio and PBoC’s reassurance).

Looking forward, there are four notable implications, which may have the impact on the real economy and banking sector.

First, banks are expected to shrink their interbank lending. Second, Interbank borrowing cost is likely to normalize further from mid-July, but is unlikely to return to the pre-crunch low level. Third, liquidity crisis is likely to speed up reforms, in particular interest rate liberalization. Fourth, the impact on the real economy cannot be discounted.

It is ironic that China’s liquidity crunch broke out in the environment of excess liquidity in China. The root of the crisis is a less developed financial market.

Although China’s two-tier interest rate market is likely to provide the buffer to the shock of money market volatility to the real economy, we think the impact of recent liquidity crunch on the real economy cannot be discounted.

The end-user of booming interbank lending is actually the off-balance sheet lending activity, which mainly supported the local government and SMEs funding needs. The deleverage in interbank business is likely to hurt SMEs. As such, credit quality is likely to be the key focus for the second half.