China Allows Banks to Trade Loans on the Interbank Market

Sources:
People’s Daily Online: Small banks get the upper hand from new policy
Istockanalyst.com: China initiates loan transfer system on Interbank market
Bloomburg.com: China Allows Banks to Sell Loans on Interbank Market
WSJ.com: China Launches Secondary Loan Market

Last week, the People’s Bank of China (PBC) established a loan trading system, officially allowing banks to trade loans on the Shanghai interbank market. By trading loans on the interbank market, banks can meet a reserve requirement (the minimum amount that deposit-taking institutions should hold against deposit liabilities) and manage liquidity. For example, banks without enough reserves can meet the requirement by purchasing funds from banks with excess reserves.

Allowing loan transactions on the interbank market in China is expected to help Chinese banks strengthen their capital and better manage financial risk. "Given the rapid lending growth in the recent past and continuously growing pressure on bank asset quality, the launch of a national interbank loan transfer trading will be significant," said PBC Governor Zhou Xiaochuan. Following the government’s economic stimulus program, the amount of new loans reached a record level of 9.6 trillion yuan ($1.43 trillion) in 2009. In an effort to prevent worsening of loan quality and asset bubbles, the government aims to limit new lending to 7.5 trillion yuan ($1.12 trillion) this year. In addition, the government requires banks to maintain a loan-deposit ratio of 75 percent. By selling existing loans, large banks will have more rooms to make more profitable loans without violating the regulatory requirement.

The National Association of Financial Market Institutional Investors (NAFMII), a self-regulatory organization in China, published rules to provide the standard procedures for loan transactions on the interbank market, how to deal with loan defaults, etc. Twenty-one banks including Industrial & Commercial Bank of China Ltd. and HSBC Holding Plc agreed to sell loans on the interbank market. One of the first transactions was executed by China’s two largest banks, Industrial and Commercial Bank of China and Bank of Communications.

Currently, only commercial banks can trade loans on the interbank market. However, the government will eventually allow institutional investors to trade loans as well, said Zhou. Also, experts say that allowing loan transactions is a preliminary move towards securitization of bank loans.

Discussion:
Will the NAFMII’s rules effectively regulate the interbank loan transfer market?