China set to provide funding to foreign banks

Chinese authorities may introduce their own version of the Federal Reserve's term auction facility (TAF) to help foreign banks get through their toughest test yet in dealing with China's still-developing interbank market.

Renminbi funding for locally incorporated subsidiaries of foreign banks has dried up in the past six weeks following the bankruptcy of Lehman Brothers on September 15, due to increased counterparty risk vigilance by Chinese banks fearful another major foreign counterparty may fail. This in turn has restricted the ability of foreign banks to conduct business in mainland China.

While quantifying the liquidity squeeze is difficult, China's renminbi interbank market saw total transaction volumes on December 5 of 42.2 billion renminbi ($6.1 billion), compared with 79.5 renminbi on the same day in 2007. Foreign banks, meanwhile, ended the day with net borrowings of 2.1 billion renminbi compared with a net lending position of 290 million renminbi on December 5 last year, according to data from China Foreign Exchange Trade System (CFETS), a unit of the People's Bank of China (PBOC) that provides systems for FX trading and renminbi lending.

Bankers in Beijing say the behind-the-scenes discussions about opening a TAF are unprecedented and are being handled by the monetary credit lending department of the PBOC, the country's central bank. The PBOC declined to comment.

But bankers said the PBOC approached locally incorporated branches of foreign banks two weeks ago, saying they may be able to seek renminbi lending from the central bank on a collateralised basis in the near future. The collateral could be in the form of government bonds and bills or US dollar cash among other forms, with funding tenors discussed as being either 20 days or three months.

The Federal Reserve in the US introduced auctions for short-term loans to financial institutions so banks could avoid the stigma related with obtaining funding from the Fed's discount window - which lends money to banks that face funding problems. The auctions were designed at the end of last year to ease interbank term money pressure.

While few details about the Chinese version of TAF have emerged, a banker at the local branch of a foreign bank in Shanghai said he believed the PBOC would offer its TAF mechanism on an unnamed basis. The minimum interest rate for TAF, meanwhile, would be set higher than the PBOC lending rate to local financial institutions. This currently stands at 3.06% for 20-day lending and 3.33% for loans of three months.

"The impression is very positive, and is in line with the policy moves made by many central banks in the rest of the world," said a banker at a foreign investment bank in Shanghai. "It does show that China wants to be at least seen as a responsible country during the crisis."

Other senior bankers said the levels of support given by the central bank are unprecedented, and the likely introduction of a TAF drew praise as a symbolic watershed. "The PBOC is taking the lead to lend to foreign banks' local branches as a vote of confidence towards foreign banks' financial health," said one banker. "The central bank is effectively asking the Chinese banks to follow suit and resume lending to us."

China, as part of its member commitments in joining the World Trade Organization in 2001, has opened its banking sector in stages to foreign banks. The China Banking Regulatory Commission began approving requests from foreign banks to incorporate their onshore units after issuing the relevant rules in November 2006, prompting a slew of foreign banks to scramble for a share of China's lucrative retail banking market.

This has led to more demand for renminbi interbank funding and the likely move by the PBOC appears to be an early step to underlining that the Chinese central bank is willing to intervene and stand as a lender of last resort for the local branches of foreign banks in times of market stress.