BEIJING – China has initiated stress tests with financial institutions on their bond investments, to make sure they can handle any market volatility should a record-breaking rally reverse, according to state-run media.
The People’s Bank of China (PBOC) has recently gradually started the tests, wary of risks that a bull run might lead to one-sided bets in long-term government bonds, according to a front-page report by Financial News. Its intention may not necessarily be to significantly push yields higher, the central bank-backed newspaper said, citing an unidentified source.
Financial institutions should be able to cope with large drops in bond prices, as crowded holdings in debt positions could easily turn into a “stampede” in the event of a sharp yield reversal, Financial News said. That can raise the likelihood of a liquidity crisis and threaten financial stability, it added.
A stellar rally in Chinese bonds stalled amid the authorities’ measures to cool the sentiment through measures including having state banks sell their bonds holdings and gathering financial institutions for meetings. That has triggered a collapse in government bond trading as investors consider the regulatory moves.
The central bank did not seek to nor will it seek to ban legitimate investments or trading in its government bonds, but it sees risks in a buying spree of the securities, Bloomberg earlier reported, citing people familiar with the PBOC’s thinking.
By doing the tests, the authorities want to see if banks can handle drastic market swings in hypothetical and extreme conditions with their current holdings of assets, the paper said. In the case of the bond market, officials may want to see how banks can react if yields surge by 10, 20 or even 50 basis points in a sudden move, it added.
The PBOC left a key interest rate unchanged on Aug 26 after warning on the bond rally.
It kept the rate on its one-year policy loans, or the medium-term lending facility, at 2.3 per cent, after slashing the rate by 20 basis points in July. Meanwhile, the central bank withdrew a net 101 billion yuan (S$18.4 billion) from the banking system in August, as 401 billion yuan of the loans expired on Aug 15.
The net withdrawal is “indicating that the PBOC is keeping reasonably ample and balanced liquidity and preventing excessive liquidity in order to curb the bond bulls”, said Mr Bruce Pang, chief economist for Greater China at Jones Lang LaSalle.
The decision underscores Beijing’s cautious approach in supporting the economy, even as China reported a rare contraction in bank loans amid weak demand. The PBOC has been walking a fine line of stimulating growth and cooling the government-bond buying spree to limit financial risks in recent months.
Financial risks in key areas are being resolved in an orderly manner, PBOC governor Pan Gongsheng said in an interview with state broadcaster China Central Television that aired on Aug 24. China will adhere to a supportive monetary policy stance and promote credit growth and gradual decline of funding costs, he added. BLOOMBERG