PBoC giving a helping hand to banks in exchange for their support to private sector

• The recent regulatory push for banks to lend to the private sector was received with dismay by bankers, worried about their profitability and credit quality. The good news is that Chinese policy makers are increasingly aware of the difficulties that banks’ are facing to shoulder such massive task and are ready to help.
• Apart from slashing banks' reserve requirements, the People's Bank of China (PBoC) is becoming increasingly innovative in trying to repair a malfunctioning transmission mechanism without resorting to the old solution in shadow banking. Hence, banks – together with the bond and stock markets – will have to shoulder the funding of Chinese firms, especially the private sector that has clearly become cash-strapped since the retreat of shadow banking.
• The targets that China imposed on bank lending to the private sector are massive that banks will need more capital to be able to expand their balance sheets at the required pace. A number of policy decisions have been announced by the PBoC to facilitate the tasks to the banks. The first is to allow the issuance of perpetual bonds both by listed and unlisted banks to replenish non-core Tier 1 capital. In addition, the PBoC has introduced two new tools. The targeted medium-term lending facility (TMLF), back in December 2018, allows banks to secure liquidity at a cheaper interest rate (15 bps lower than the existing medium-term lending facility, MLF) as long as the funds are relented to small and private firms. A third policy announced only last Thursday is the creation of the central bank bills swap (CBS), which banks can exchange their holdings of perpetual bonds with PBoC paper. This will clearly enhance the demand of perpetual bonds as banks will be allowed to exchange a risky asset (banks’ perpetual bonds) with a safe one (PBoC bill).
• For many, the fact that China’s central bank swaps perpetual bonds and keeps them is a form of quantitative easing (QE). But the PBoC may not agree as the arrangement is not an outright purchase but a three-year holding of a perpetual bond, which will be returned to the bank once the PBoC bill expires. As if this were not enough, the PBoC will also accept perpetual bonds as collaterals for targeted lending tools, including the new TMLF.
• We believe the two new tools and the expansion of collateral pool are strongly linked to the support for China’s cash-strapped private sector. In other words, banks will be supported while obliged to lend for China to stem off its rapid deceleration. The ultimate consequences of all of these are yet to be seen, but it is clear China is ready to do whatever it takes to grow, no matter whether you define it as QE or not.

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