Question

Topic: Open Market Supply SHANGHAI -- Money markets are often described as the financial system's plumbing....

Topic: Open Market Supply

SHANGHAI -- Money markets are often described as the financial system's plumbing. When they work, which is most of the time, hardly anyone notices, but when they get blocked up, it creates quite a stink.

That is why China's money market -- in which banks and other financial institutions borrowed some $6.4 trillion from each other last month alone to fund their daily needs -- is becoming one of the world's most important markets to watch.

China's central bank has raised interest rates twice since early February. That immediately pushed funding costs to the highest in two years, hitting smaller banks that have come to rely on the market particularly hard. Last week, some small rural banks failed to make good on short-term loans from other lenders.

And while anxiety in the market has eased somewhat this week, short-term borrowing rates are still high. Brokerages and asset managers are having to pay interest of as much as 6% on short-term borrowings, more than double the central bank's benchmark rate.

Tightness in money markets is a worry because if banks stop lending to each other, they soon stop lending to the broader economy, too. A sharp rise in interbank borrowing costs thanks to a liquidity crunch in major Western markets in 2007 heralded the global financial crisis. China's money market has become just as central to the country's financial system as those of its U.S. and European counterparts after rapid expansion this century.

That has handed a new lever to the Chinese central bank, which is using money-market interest rates as its main tool to control the amount of money in the country, a big change from the days when it ran the economy by directly controlling banks' total lending.

But as the money market becomes more influential, so has the risk of widespread damage to the world's second-largest economy when it jams up.

"Because there's been a trend for small banks and nonbank institutions to play a larger role in the money market in recent years, the risk of a liquidity crisis is growing," said Julian Evans-Pritchard, a Singapore-based economist at Capital Economics.

China's banks for years relied on deposits from ordinary customers. As the economy expanded and banks lent more aggressively, they borrowed more from each other in money markets to get extra funding. Typical borrowers are smaller banks, which have lower deposit bases, while large banks flush with funds, such as Industrial & Commercial Bank of China Ltd., act as lenders.

The volume of interbank lending, usually uncollateralized, hit a record with the equivalent of $34 trillion in loans last year, nearly 100 times the amount of lending in 2002 when data provider Wind Info's full-year records began.

Banks also use large amounts of repurchase agreements, or repos, in which one bank borrows in the short term from another, typically using a Chinese government bond as collateral. Turnover in the repo marketsurged to the equivalent of $216 trillion last year, about 24 times its volume a decade ago.

China's central bank plays a big role, using daily open-market operations to adjust the supply and cost of funds in the financial system. When there is a cash shortage, it offers loans to banks, usually ranging from seven to 28 days. Its seven-day repo rate has become its main policy tool, the equivalent of the fed-funds rate.

What is worrying China's central bank is that lenders are plowing the funds they raise in these markets into speculative investments, fueling asset bubbles.

One big problem is the rise of what are euphemistically called wealth-management products. The products bundle together all sorts of assets or debt, even other wealth-management products, and aren't transparent. These are sold to bank customers offering much higher returns than ordinary deposits, by making big, leveraged bets on everything from government bonds to garlic. Critics consider them a big risk to banks and individual savers, with the outstanding amount issued having ballooned to the equivalent of $3.8 trillion, or 35% of gross domestic product.

Because the products are often short term, there is a risk investors won't be repaid if the value of the investments drops sharply. At that point, the issuers of wealth-management products often look to tap the money market to get the funds they need to pay back investors, a problem if rates have risen.

Beijing has set reducing the country's debt buildup and high leverage in financial markets as a top policy priority. The central bank has raised its seven-day repo rate twice recently, its first increases since October 2015.

As interbank borrowing rates soar, they are feeding through to hurt China's already slowing economy, as banks pass on the higher costs.

A quarterly record of 104 companies have dropped or delayed the equivalent of $14.1 billion of bond-issuance plans since the start of this year, according to Wind Info.

The central bank's control over China's markets is also being tested. After the latest rises, its seven-day repo rate remains a low 2.45%. But big state-owned banks that borrow directly from the central bank are charging much higher rates when they lend to smaller institutions.

"That means the transmission mechanism is not well developed, which can dilute the effectiveness of policy changes," said Tim Condon, economist at ING. China's money market is distorted by the big five state banks that dominate the supply of funds, he said.

1. From the article above, briefly explain the author's purpose for writing the article.

2. Summarize the article, focusing on the discussion of the topic the article addresses. Define the economic concept being addressed. Incorporate relevant economic theory that is present so that discussion of the article content is clear.

Word Count MUST be 300 words

Homework Answers

Answer #1

1. From the article above we find that the author is explaining about the development of money market in China following in the footsteps of European countries and other advanced economies where the supply and demand for funds is directly impacted by the Central bank using the tools such as its benchmark interest rate.

The author warns about the fund crunch in the world's second largest economy and why the rise in interest rate has not worked as efficiently. That means the transmission rate doesn't work as effectively as it should. The funds are being invested in bubble assets where it doesn't help the economy in general.

2.

The economic concept being used is the money supply tool of the central bank.

As the interest rate rises to cool down overheating economy, the funds move to the financial institutions. Investment and saving rises due to expectation of higher return.

Despite the growing debt problem, China is trying to further stimulate lending of the corporate sector, especially small and medium-sized companies. On Monday, May 9, Bank of China announced another cuts in reserve requirement ratios. As a result, banks will have an additional 280 billion yuan (41 billion dollars) to be used as loans to companies with financial problems. That reduction would be divided over three stages, on May 15, June 17 and July 15. On Tuesday, May 21, they released statement saying that they had cut the ratio by 1% on May 15, and the next 1% cut is expected to be on June 17.

On the other hand, Chinese officials along with President Xi Jinping are trying to reduce shadow-banking system (financial intermediaries who provide services similar to traditional commercial banks, but are not subject to traditional banking regulations). In effect, we come to a situation where commercial banks are reluctant to continue lending to companies with a poor financial conditions also, more restrictive regulations on shadow-banking make it impossible for these enterprises to borrow outside the banking system.

All these aforementioned factors translate into the economy state, and this one currently does not look bright.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
During "normal times" the Federal Reserve pursues open market operations to affect the money supply and...
During "normal times" the Federal Reserve pursues open market operations to affect the money supply and interest rates in the economy. For instance, during normal times, if the FED wanted to reduce short-term interest rates, it would buy short-term Treasury securities from the public. The FED's purchase of securities allows it to inject liquidity (money) to the financial system. In contrast, during "exceptional times", the FED may pursue "unconventional" monetary policy to affect interest rates. During the implementation of the...
China Moves to Tighten the Money Supply By DAVID BARBOZA – January 6, 2007 China’s central...
China Moves to Tighten the Money Supply By DAVID BARBOZA – January 6, 2007 China’s central bank said late Friday that it had raised the reserve requirement ratio for banks, the fourth increase in six months, to further tighten the nation’s money supply. The modest move, which takes effect this month, increases the reserve ratio by half a percentage point, to 9.5 percent. Analysts said it was the government’s latest warning that too much money in the financial system could...
1. If China is going to maintain its peg with the dollar despite its trade surplus,...
1. If China is going to maintain its peg with the dollar despite its trade surplus, what must the Bank of China do if it has no Sovereign Wealth Fund? a.   Short sell dollars in exchange markets b.   Reduce its vast holdings of dollars c.   Increase its holdings of dollars d.   Raise the value of its currency to discourage export surpluses e.   Create a new currency 2. Pick the two answers to the following: What would be the immediate effect on M1 of a bank...
QUESTION 6 Firm A has assets that are mainly in financial securities and whose liabilities carry...
QUESTION 6 Firm A has assets that are mainly in financial securities and whose liabilities carry variable interest rates; Firm B has the same assets as Firm A and the same amount of liabilities but its liabilities are all at fixed interest rates. If the central bank lowers interest rates, everything else constant: a- The net worth of both firms will increase and by the same amount. b- Neither firm's net worth will change. c- Firm A's net worth will...
Please paraphrase this writing and fix them as possible as you can. thanks! Since the interest...
Please paraphrase this writing and fix them as possible as you can. thanks! Since the interest rate in China makes the banks are hard to build up their loan books, that’s why in 2015, the central banks set their lending and deposit rate. This can be an opportunity for the banks to release their stress on credit and eliminate the deposit loan. The answer has been to create a policy rate, much like benchmark short-term interest rates in America and...
Please Answer all of them, I don't have much time, Thank you 68) Large firms tend...
Please Answer all of them, I don't have much time, Thank you 68) Large firms tend to be A) net users of trade credit. B) net suppliers of trade credit. C) firms with high levels of profitability. D) firms with low levels of inventory turnover and accounts receivable turnover. 69) From the banker's point of view, short-term bank credit is an excellent way of financing A) fixed assets. B) permanent working capital needs. C) repayment of long-term debt. D) seasonal...
Multiple Choice 9. Banks see a decrease in the value of its bond and loan portfolios...
Multiple Choice 9. Banks see a decrease in the value of its bond and loan portfolios when interest rates: A. decrease. B. increase. C. either increase or decrease. 10. Since the corona virus hit the U.S. in March, the stock market, as represented by the Dow Jones Industrial Average, is currently down approximately: A. 15% B. 30% C. 40% D. 50% 11. The risks that banks see the value of its bonds and loan portfolios when interest rates: A. decrease....
23. The level of the money supply is determined by the level of economic activity and...
23. The level of the money supply is determined by the level of economic activity and adjusted at the margin via the implementation of monetary policy by the Federal Reserve. Thus, the U.S. is said to have: (a) an “elastic currency;” (b) a gold standard; (c) a rule-based monetary policy; (d) an independent central bank. 24. The Employment Act of 1946 established the original monetary policy mandate of the Fed. It called for: (a) balancing the federal budget deficit; (b)...
The main advantage of using the interest rate, rather than the money supply, as the policy...
The main advantage of using the interest rate, rather than the money supply, as the policy instrument in the dynamic AD–AS model is that it is more realistic. Today, most central banks, including the Federal Reserve, set a short-term target for the nominal interest rate. Keep in mind, though, that hitting that target requires adjustments in the money supply. For this model, we do not need to specify the equilibrium condition for the money market, but we should remember that...
The main advantage of using the interest rate, rather than the money supply, as the policy...
The main advantage of using the interest rate, rather than the money supply, as the policy instrument in the dynamic AD–AS model is that it is more realistic. Today, most central banks, including the Federal Reserve, set a short-term target for the nominal interest rate. Keep in mind, though, that hitting that target requires adjustments in the money supply. For this model, we do not need to specify the equilibrium condition for the money market, but we should remember that...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT