China backs interbank collateral

China backs interbank collateral
The Chinese government on Friday said that it will soon allow borrowers to use offshore foreign currency bonds as collateral for interbank loans. This is a step further towards liberalizing the country’s capital..

The Chinese government on Friday said that it will soon allow borrowers to use offshore foreign currency bonds as collateral for interbank loans. This is a step further towards liberalizing the country’s capital markets. 

Background 

In 1905, China's first central bank was established as the Bank of the Board of Revenue. Three years later, its name was changed to the Great Qing Government Bank . Intended as a replacement for all existing banknotes, the Da Qing Bank's note was granted exclusive privilege to be used in all public and private fund transfers, including tax payments and debt settlements. Da Qing Bank was also given exclusive privilege to run the state treasury.

The Nationalist government created the Central Bank of China in 1928, with T. V. Soong as its first president. The Bank of China was reorganised as a bank specialising in the management of foreign exchange while the Bank of Communications focused on developing industry.The decade from the Northern Expedition to the Second Sino-Japanese War in 1937 has been described as a "golden decade" for China's modernisation as well as for its banking industry.

According to certain forecasts, China’s GDP growth is slated to overtake America’s GDP in another 10 years. A hub for the manufacturing industry, China is the fastest growing economy. Its economic growth has been over 10% for over 30 years.The International Monetary Fund endorsed China's Yuan as a reserve currency two years ago -- putting it in an elite club that includes the U.S. Dollar and the British Pound. The GDP growth rate in China was 6.7% for 2016. 

According to the Chinese government, due to a rise in exports, construction and consumer spending, the economic growth rate for 2017 was 6.9%. This beat industry expectations as well as projected estimates. This is also the first time in seven years the speed of China's economic growth went up rather than edging down. The figure also beat Beijing's official annual expansion target of about 6.5%.

Foreign Exchange Reserves in China Averaged 977489.44 USD Million From 1980 Until 2018, Reaching An All-time High Of 3993212.72 USD Million In June Of 2014 And A Record Low Of 2262 USD Million In December Of 1980.

Analysis 

China’s move to introduce a foreign currency lending system is considered a further step in liberalizing the country’s capital markets. It will now consider to allow borrowers to use offshore foreign currency bonds as collateral for interbank loans.

The China Foreign Exchange Trade System said on its website that it would introduce the use of such bonds for collateral on its foreign exchange trading platform on July 23.It said the move was intended to “enrich foreign currency financing tools, and to further satisfy the asset and liability management needs of domestic and foreign currency-lending institutions.”

The new lending business is expected to support transactions using the U.S. dollar, euro, Hong Kong dollar, Japanese yuan, Australian dollar and Canadian dollar, and can handle transactions in the same currency or between different currencies.This will invite foreign currency in the Chinese economy.

China’s equity (second largest by total market cap) and bond (third largest) markets are among the biggest globally and are almost entirely funded by domestic investors. Heavy regulation has prevented non-mainland-Chinese investors from owning more than a smidgen of Chinese assets. For instance, foreign currency borrowing still accounts for less than 5% of total credit in China’s financial system.But this is set to change with the addition of onshore stocks into MSCI’s index family and the latest expansion of the Connect scheme, both of which share the vital goal of enticing foreign ownership of mainland assets.

Investors who take the plunge into Chinese government bonds will of course need to consider the currency risks, given the ongoing trade war.Renminbi hedging costs have lowered substantially this year. As a result, net of hedging costs, five-year Chinese government bonds now offer yields not far from five-year US Treasuries. For investors, such changes in market dynamics give them the choice of running Chinese government bonds in local currency, or US dollars. Without foreign exchange risks, the potential for capital gains may indeed look more appealing, particularly for foreign investors.However, Chinese bonds seem to be the unlikely winners of the ongoing trade war.

As the country continues to peel back layers of regulation, China has the potential to rival the US as a global financial hub. With increased investment, China’s financial markets can become the world’s largest. In tandem with ongoing efforts like the internationalisation of the renminbi, China’s Long March to a free market should consolidate its leadership in finance, even if not immediately

Assessment

Our assessment is that this move will support the ailing Chinese economy as trade tensions escalate between US and China, depreciating the Yuan. We feel that this move will be welcomed as China’s counterparts as it shows their commitment to liberalizing the economy.

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