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Dive! Take cover! Or, at least, hold on to your pants in the scramble. The Chinese bubble has just burst. It looks like the world is going to have egg on its face and elsewhere as Chinese banks are scrambling to get the hands on cash.

Chinese cash rates didn’t just increase they shot through the roof today, Friday June 21st. This is not hyperbole. This is not exaggeration. They reached 25% when they were at their peak, and the only thing that calmed them down was the talk of a possible cash injection from the Chinese central bank. Rates dropped to 10%.

Some analysts are saying that the People’s Bank of China is trying to make a point to smaller banks that are using short-term funding for trading rather than lending that money out. That’s dicing with death some analysts reckon as some of the smaller banks are nearing collapse.

Overnight bond purchase rates are the measure of the cost of liquidity and the rates are double what they are expected to be at the present time (8.4920% today, which is lower than Thursday’s 11.62%, but still higher than they should be).

Two banks have refused to acknowledge that they received emergency loans from the People’s Bank of China last night to bail them out of trouble. Others say that they are strapped for cash. To boot, they are not just the small fish in the financial banking sector. The world’s largest bank in terms of assets was mentioned as being one of those banks (The Industrial and Commercial Bank of China). If the biggest banks in the world are currently strapped for cash, because they have been trading with that cash, then we may be preparing for another financial meltdown around the world. This time the question is: will it be bigger than the 2008 one? By the looks of it, yes. In 2008, China suffered also from the financial crisis around the world, but managed to maintain some sort of economic growth. Have the financial crisis and poor banking practices trickled through to the Chinese banks today leaving them without a cent available?

People's Bank of China

However, rates have not, according to analysts affected the economy as of yet. State-owned enterprises have enough cash for the moment to be able to get through a credit squeeze if there is one, although small companies are suffering already, apparently. Some are saying that the credit crisis is like nothing that we have ever had to go through yet.

All eyes are fixed on the Shibor (Shanghai Interbank Offered Rate), which is calculated by averaging all the interbank lending rates. There are 18 commercial banks included in the price quotation and it is the barometer of Chinese credit liquidity. The two charts show the worrying progression of the Shibor.

China: O/N Shibor

China: Shibor 21st June 2013

The Libor surge prior to the Lehman Brother’s bankruptcy and the ensuing spiraling fall to hell recall the somber times of the financial crisis in 2008. Are we in store for the same?

But, the economies of China and the western world back in 2008 are not identical. Mature economies would be begging the central bank to act and double quick. Such high rates of interbank lending in the western world would scare the banks out of their living daylights. China often sees banks strapped for cash in particular just before holiday seasons when people tend to withdraw greater quantities of cash. Deposits dry up regularly before Dragon Boat Festival, so that’s nothing new. What is new, however, is that the People’s Bank of China has done little to ease that situation. In fact, it has made it worse, by withdrawing liquidity by selling three-month bills. China sold CNY2 billion in bills on Tuesday (at a yield of 2.9089%). This was the starting gun for the message that was winging its way to the banks in China telling them that they had to start lending, as the People’s Bank of China would not come to their aid. With liquidity being withdrawn, banks decided to hoard cash and stop lending. The credit squeeze was on and liquidity became scarcer. The Shibor has shot through the roof because there is a fall in trust regarding the creditworthiness of Chinese banks right now.

Some might well criticize China’s madness regarding the flirting with the Shibor. But is there a method in their madness? Will banks have to maintain credit availability and also keep sufficient deposits on hand in case there is a run on the banks. Up until now, the banks have been slowing down their availability of loans which is causing damage to the Chinese economy, resulting in a slow-down in economic activity. But, now that the message has been given loud and clear that the People’s Bank of China is not prepared (at least, not immediately) to give a helping hand if they go under, they will have to stand on their own two feet. Trouble is, it seems a bit of a blast from the fire-eating dragon.

One or two banks might end up getting burnt and in the process set fire to a few of us in the meantime.

Originally Posted: Chinese Banks Ready to Go Bust

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