Liqudity: a thorny issue

The report said short-term liquidity conditions may be further stressed by the required reserves due at the end of the year. If the central bank continues its SLO or other open market operations, the surge of interbank lending rates may be eased. In the mid-term, liquidity conditions in China's capital markets may be worsened by more cash demand before the Chinese New Year, which falls on January 31 this year, and the US Federal Reserve's (Fed) decision to taper its quantitative easing (QE) program, according to the report.

Yi said the credit crunch between banks is a result of the following factors. "First, banks face the pressure of handing in the required reserve. Second, the central bank unexpectedly canceled repo for five consecutive times. Third, the US Fed has been cutting QE faster than people have expected. Finally, a considerable amount of deposits left banks for Internet finance, dealing a heavy blow to Chinese banks," he said. "As a result, all financial institutions line up to get loans and the credit crunch is destined to happen."

The crunch is also related to severe imbalances in China's lending structure. China pumped billions of dollars of funds into its economy to prop up growth in the wake of the global financial crisis. A large amount of money went to the property sector, government-backed financing platforms and sectors with excess capacity. Meanwhile, only 5 percent of the real economy is funded by bank loans. Therefore, it's not a lack of money but a severely distorted lending structure.

Risks in money management products also exacerbated the crunch. At the end of each quarter, many of these products are due for redemption. Chinese-funded banks also have to meet the loan-to-deposit ratio of 75 percent. At the end of each quarter, they are subject to supervision from regulatory bodies. Therefore, credit crunch often happens at the end of a quarter or the year.

Frequent occurrence

A report from China International Capital Corp. Ltd. said the problem of frequent liquidity shortages haven't been fully solved, despite the easing of the recent shortage. Credit crunches may become a common phenomenon for three reasons—bank asset growth exceeding debt growth, no cash flows generated by the particular bank that needs cash, and poor preparation for separation of interest rate and finance from the department of assets and liabilities in banks.

A financial blue book issued by the Institute of Finance and Banking of the CASS on December 25 said the monetary market will continue to be tight in 2014, just as it was in 2013. If reforms on local government debt, the property market and state-owned enterprises are carried out, the money supply situation can be improved.

Yi said timely intervention from the central bank immediately eased capital stress in banking system in December, but the real solution lies in banks. "It's extremely important for commercial banks to adjust their balance sheets flexibly and to better manage the liquidity issue."

The Central Government made it plain that China will continue to follow a prudent monetary policy in 2014 and added that money supply should serve the development of the real economy. However, alongside the rapid development of Internet finance and the shadow banking system, more capital will bypass banks and directly get to those who need money. Therefore, liquidity shortages will be a common phenomenon.

Yi said a cash injection can't solve the problem. "Frequent occurrences of credit crunches mean there's something wrong with China's lending system. If the central bank only pushes money into the markets and doesn't launch reforms accordingly, the Chinese-style credit crunch is bound to happen again in 2014.