World Economy

China’s Smaller Lenders a Risk to Bank Sector

China’s Smaller Lenders a Risk to Bank SectorChina’s Smaller Lenders a Risk to Bank Sector

China’s banking system faces a systemic risk from a significantly increased reliance by small and mid-tier lenders on interbank funding, top credit rating agency Moody’s Investors Service warned on Monday.

The most liquid assets of these banks are held largely as interbank assets, so they would need to withdraw funds from other banks to meet their own funding needs, which could in turn cause contagion, Moody’s said in a report, Reuters said.

“With an increasingly larger number of banks now more actively engaged in the interbank financial product business, the banks are becoming more sensitive to the risk of potential counterparty failure, which could magnify any collective reaction to negative news and trigger a sharp tightening in system liquidity,” said Christine Kuo, a Moody’s senior vice-president.

In contrast, China’s big four banks are not dependent on the interbank market and are mostly fund suppliers, reflecting their strong deposit base and more prudent growth strategy, the credit rater said.

Banks outside the big four have increased their reliance on short-term funds in recent years, exposing individual banks to a higher risk of funding disruptions, such as a spike in funding costs, Moody’s said.

Traders said these banks’ reliance on seven-day funding was reflected in the central bank’s money-market operations last week, when it guided the market towards a longer tenor by issuing 14-day reverse repurchase agreements for the first time since February.

Some analysts say the major worry for policymakers is that the over reliance of smaller banks on short-term interbank borrowing to fund bond purchases was threatening to cause an asset price bubble.