China's capital market could experience a liquidity shortage after Chinese banks extended fewer loans in May and the People's Bank of China drained 30 billion yuan in open market operations.

According to the official China Securities Journal, new lending by the nation's Big Four state-backed banks in May totaled 253 billion yuan ($39.75 billion), while credit across all financial institutions grew an estimated 700 billion yuan. The Big Four banks -- Industrial and Commercial Bank of China Ltd.(SH601398, HK. 1398), China Construction Bank Corp.(SH.601939, HK.0939), Bank of China Ltd (SH.601988, HK.3988). and Agricultural Bank of China Ltd.(SH.601288, HK.1288) -- typically account for 30-40 percent of total bank lending.

Moreover, banks speeded up extending credit towards the end of May following a sluggish start to the month. New lending in the first 14 days was virtually flat, while deposits fell by 200 billion yuan from April.

New yuan-denominated bank lending in 2012 will total around 7 trillion yuan ($1.1 trillion), lower than the government's unofficial target of 8-8.5 trillion yuan ($1.26-$1.35 trillion).

Reuters reported on Tuesday that China's central bank will drain 30 billion yuan from the money markets through 28-day bond repurchase agreements on Tuesday.

"Money is still ample today, but we can feel the money demand is stronger than previous days," said a dealer at a state-owned bank in Shanghai.

Demand for funds was also fuelled by a bond auction by China Development Bank, which sold a total of 30 billion yuan in one-, three-, five-, seven- and ten-year bonds.

China's interest-rate swaps (IRS) rose slightly on Tuesday, with one-year interest-rate swaps rising to 2.43 percent - up seven bps from Monday's close - and five-year IRS up 2.75 percent by midday from Monday's 2.67 percent.

A slowdown in lending brings the risk of banks failing to meet the central government's annual loan growth target for the first time. They are also faced with the prospect of weaker loan demand from enterprises and strict loan-to-deposit ratios.

Luckily, the central government loosened monetary policy in May to secure stable economic growth and speed up the approval of infrastructure projects, meaning banks can fuel the pace to offer more lending.

And last week, China's top planning body said it would accelerate the approval of investment projects, with 100 projects approved in a single day, which indicates the authorities are keen to boost investment in pursuit of steady economic growth, according to the official.

Web link: http://morningwhistle.21cbh.com/html/2012/FinanceMarkets_0605/212532.html

KPMG financial chief believes wider reform still needed before city becomes global center
Simon Gleave believes the violent capital flows currently being witnessed within the eurozone is making China's policymakers nervous about opening up its own capital markets.

The 49-year-old regional head of financial services for KMPG Asia Pacific thinks there are parallels between the establishment of a European single currency and fully integrating China into the global financial system.

"The only comparable example you might have (to China opening up its capital markets) is the formation of the euro mechanism. It was supposed to get rid of all the imbalances of the past but the reality is that it is about to become the world's biggest bust," he says.

Gleave, who advises some of China's big State-owned banks as well as Chinese regulators, was speaking from his company's office in one of the towers at Oriental Plaza, considered one of Beijing's most prestigious retail and commercial complexes.

He insists, however, it is not just the current market turmoil that has delayed the establishment of an international board for foreign companies to list on the Shanghai Stock Exchange, but an understanding of the need for wider reform before this can happen.

He stands by the view of his company's joint report last year with the FTSE Group and Dagong Global Credit Rating, China's Capital Markets - the Changing Landscape, that Shanghai is on course to become the world's largest financial center by 2020. "That is the government's policy and we can see it happening. To be a global financial center, however, you have to open capital markets, or else you just end up being a big domestic center which we currently are," he says.

Gleave, who is one of KPMG's leading experts in his field, says it is actually vital for the economy as a whole that Shanghai becomes a global financial center in a relatively short time frame and that waiting until 2030 or 2040 would prove damaging.

"China is creating all this wealth and this wealth needs to be managed and not sat under the bed," he says.

"Well managed wealth - as in a strong financial sector with good capital markets - is vital for creating economic growth. That is the purpose of a financial sector."

But Gleave is not surprised by the current delay in establishing an international board at Shanghai and believes it never was a realistic prospect for it to go ahead without key capital reforms being in place.

These reforms would range from allowing more competition in the banking system to full convertibility of the yuan.

"You can't really do it because all you would come up with a restricted system and the logical one would be to have the local subsidiary of a foreign company listing and neither party really wants that. You might do it as an intermediate step but it is just not that attractive," he says.

The central problem in China - where converting the yuan into foreign currency is restricted as a result of exchange controls - is that those listing in Shanghai under the current system would not be able to get any money they raised out of the country. It would also stifle any attempts to arbitrage so the same company listing in Shanghai could end up with a very different share price to that in London or New York.

"It is a fundamental problem. You can't have the same shares in one market worth $10 (8 euros) and in another $100," he says.

"If a share price is higher in Hong Kong than in London, shares flow from London to Hong Kong, creating extra supply and so the price goes down. That is arbitrage. Without free capital markets that can't happen in China."

Gleave says a restricted Shanghai board would sit very oddly in an international financial system that sees trillions of dollars move round the world at an instant.
"The arbitrage nature of shares requires very high level of cash flows. People are constantly buying and selling on arbitrage investments. Buying and holding shares is a very small proportion of the market," he says.

Gleave, who was brought up in Hong Kong of an Australian father and an Italian mother, earned a Master of Science in engineering at Imperial College London and then an MBA from the University of Wales in Cardiff, before joining KPMG as an accountant in London.

After returning to Hong Kong, he was posted to Beijing 12 years ago and assumed his wider Asian role two years ago.

He regularly speaks to KPMG's clients not just in Asia but also in Europe and North America and about China and its financial system.

"It is sometimes frightening to discover how little people actually know about the mainland, even in Hong Kong, where people live in their own particular porcelain towers and think they are at the center of the universe," he says.

"If you live in the mainland, you learn a million times more than if you read newspapers printed in Hong Kong. It is as simple as that," he says.

He says there is no lack of interest among major international companies wanting to list on the Shanghai stock exchange.

"I have worked with several clients on prelisting work ready for listing in China and there are a lot of institutions around the world, both in the financial and energy sector who would like to come as part of their global strategies," he says.

Gleave says it is wrong to assume that some of the major companies want to list to raise money from Chinese investors to fund their expansion plans in China.

"It is not necessarily the case, most of these global institutions don't need capital. HSBC doesn't need capital. The bank was formed initially in Hong Kong and Shanghai and they strategically wish to return to Shanghai because it is part of their core. They want to be able to say: 'We are back'," he says.

"If for example you were a European bank and wanted to be a big bank in America, one of the ways you can make your brand attractive is to trade on the capital markets.

"If these companies simply wanted funds to expand in China, they could simply go and get a loan from Chinese banks without listing."

Gleave believes many people underestimate the magnitude of the step China needs to make to open up its capital markets, since it will also open it up to a whole new culture.
"You would be suddenly opening up what is a centrally controlled and protected market to the global capital markets," he says.

"You go to New York and find out what some of these people are really like. They are not nice people. These are people who want to trade risk and make a fast buck. This is a very different world."

Gleave believes an international board in Shanghai would be more realistic when steps have been taken such as the full convertibility of the Chinese currency.

He does not believe full convertibility would necessarily produce the major shock to the economy that some assume and that the yuan would suddenly rise uncontrollably and destroy the export sector.

"I think people overestimate the impact this would have on the value of the yuan. With an economy like Malaysia's, big cash flows could affect the value of the currency. China, however, is on a much bigger scale," he says.

"So long as you have adequate liquidity prepared for this expected inrush, you should be OK. The yuan can be sold as fast as people are buying it. It is still a big barrier but I think it is a manageable barrier."

Gleave says the specter of the Asian financial crisis still hangs over any debate about the financial opening up of China.

"It was a big lesson to learn when you had all these excessive capital flows. Some countries like Malaysia, for example, just closed their capital accounts," he says.

"China wouldn't want to expose itself to that kind of risk. It would be too painful. It will want to chart a step-by-step approach that would avoid the possibility of disrupting millions of people's jobs."

Web link: http://europe.chinadaily.com.cn/epaper/2012-06/01/content_15444833.htm