The liquidity crunch that hit the mainland's money market this week underscores the top leadership's determination to deleverage an economy facing mounting financial risks.
That is likely to benefit long-term economic growth - but at the cost of market volatility and the profits of banks.
The seven-day repurchase rate surged to a record high of 12.45 per cent on Thursday from about 3 per cent in May, roiling the interbank lending market in the world's second-largest economy.
Some calm returned yesterday with talk the central bank had directed the biggest state-owned lenders to extend more short-term funding to small banks.
The credit squeeze came as a surprise because China has the world's largest M2 money supply. An abrupt drop in foreign exchange inflows and central bank measures to restrict wealth management products (WMP) were the immediate causes of the crunch, economists said. They added that the leadership's hawkishness, reflected in its keeping of "prudent" monetary policy, disappointed banks, helping drive rates higher.
"China's macroeconomic policies will involve less intervention in the case of short-term economic and financial fluctuations," Ba Shusong, a researcher at the State Council's Development Research Centre, said on his Sina Weibo microblog yesterday.
The government "will not rush to expand money supply because of a short-term economic slowdown anymore", he added.
The top leadership wants to deleverage and rebalance the economy, following its four trillion yuan (HK$4.54 trillion at the time) stimulus package in response to the 2008 global financial crisis. The stimulus exacerbated China's reliance on investment, created asset bubbles and raised the risk of a surge in bad loans.
While banks had hoped the central bank would cut their reserve ratio requirement to ease liquidity pressures, when Premier Li Keqiang chaired a State Council meeting on Wednesday, he gave no indication the People's Bank of China would ease credit conditions. Instead, the cabinet vowed to "strictly" prevent financial risks.
The leadership's stance was "positive for the development of the financial markets and China's economy over the longer term", analysts at Barclays Capital said yesterday. They expected short-term rates to remain high, which could stress the market.
Liquidity conditions usually tighten at the end of each quarter, as banks scramble to increase deposits to meet regulatory requirements for loan-to-deposit ratios. A bank source said banks lent aggressively in the first 10 days of the month in anticipation of monetary easing after May economic data suggested a further slowing in growth.
Charlene Chu, an analyst at Fitch Ratings, said persistent tight liquidity conditions could affect the ability of some banks to meet upcoming obligations on maturing wealth-management products. She estimates that more than 1.5 trillion yuan (HK$1.9 trillion) of products mature in the last 10 days of this month.
Small banks are believed to have been hit the most by the squeeze, because they are major borrowers in the interbank market, after having lent aggressively to expand.