China's central bank bans longer-tenor NCDs to close bank funding loophole

China`s central bank has barred financial institutions from issuing certain kinds of interbank loans as a funding loophole, as it continues to keep a tight grip on the potential for speculative financing.

Institutions will not be allowed to issue negotiable certificates of deposit (NCD) - a popular short-term debt instrument for smaller banks in the interbank market - with a tenor exceeding one year from Sept. 1, the People`s Bank of China said on Thursday. NCDs with a tenor of one year or less - which have fixed coupons - can still be issued, it said.

While NCD issuance has recently attracted the attention of authorities attempting to crack down on risky financial practices, the move took some in the market by surprise.

"Everyone is still trying to decipher the impact of this move. Just now, the price of one-year Shibor interest-rate swaps jumped around within a 1 basis-point range, but the direction wasn`t very clear," said a trader at a regional bank in Shanghai.

But analysts at CIB research said in a note the broader impact of the latest announcement may be limited as longer tenors comprise a small fraction of the overall market.

NCDs with tenors exceeding one year make up just 1.67 percent of a total 8.4 trillion yuan ($1.27 trillion) of NCDs, CIB research said.

Yun Xiong, partner at Lingwang Fund in Shanghai, said the move reflected central bank efforts to prevent banks from using these longer-tenor NCDs, which have floating coupons, to raise funds.

Banks have "used investors` (lower) sensitivity to credit spread on floating coupon bonds to reduce...funding cost," he said. "This normally never happens in developed markets, so PBOC`s announcement will cut off such deals."

The PBOC said earlier this month it would start to include NCDs with tenors of up to one year, issued by banks with assets of more than 500 billion yuan ($75.1 billion), in its quarterly macroprudential assessment (MPA), from the first quarter of 2018.

But longer-tenor NCDs were never to be included in that assessment.

Issuance of NCDs has risen quickly over the last year, with smaller lenders aggressively raising money via the instruments, and then using the proceeds to make higher-yield, risky investments.

($1 = 6.5996 Chinese yuan)

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