The financial landscape currently reveals a structural rise in capital costs. This phenomenon has led to short-term interest rates surpassing those of medium- and long-term durations, resulting in a reversal of the usual yield curve—a situation that raises eyebrows among economists and finance professionals.
Observations from the money market indicate a persistent upward movement in the average rates of funds. As of February 20, the rates for various tenors of repos, specifically DR007, DR014, and DR021, were recorded at 2.123%, 2.040%, and 2.080%, respectively. These figures outpaced the one-month rate of 1.97%, highlighting a clear distortion in the expected pricing of risk associated with loans and borrowings.
Overall, capital rates in the market are on the rise, a trend that has seen the central trajectory of DR001 jump from a mere 1.5% at the end of last year to around 2%. This escalating cost of funds is not merely an isolated occurrence; it represents the systemic pressures building up due to various macroeconomic factors.
Moreover, banks are navigating through a tightening liquidity environment, compelling them to seek refuge in the interbank certificate of deposit market as a means of capital replenishment. As of mid-February, approximately 40 banks have disclosed their deposit record plans for 2025, with aggregate issuance scale crossing the staggering amount of 10 trillion yuan.
Industry insiders suggest that the pressures on commercial banks are heightened, especially on the liabilities side. With a confluence of market disruptions, liquidity tightening has been underway since February, leaving banks with limited options for stabilizing their funding positions. The anticipated adjustments to the Loan Prime Rate (LPR) alongside potential reductions in the reverse repo rate might provide some room for maneuver. These adjustments have elicited keen interest in the forthcoming sessions of the National People's Congress, where discussions regarding counter-cyclical monetary policy tools will be closely scrutinized.
As we progress through the year, the financial distress on banks’ liability sides becomes increasingly pronounced. Data indicates a dramatic shrinkage of non-bank deposits amounting to nearly 4.48 trillion yuan between December 2024 and January 2025, a statistic that includes a single-month drop of 1.04 trillion yuan in January alone. Additionally, major state-owned banks saw a decline in unit deposits by 393.3 billion yuan in January.
This downward trend can be closely tied to the newly instituted regulations on non-bank deposits, implemented in the final quarter of 2024. These restrictions effectively cap interest rates and undermine the relative pricing power of major banks, consequently diverting deposits to regional lenders. Bank representatives have voiced concerns about the diminishing deposit offerings compared to small and medium-sized banks, particularly affecting higher-yield products like structured deposits.
The outflow of deposits undoubtedly disrupts banks’ asset management capabilities, which in turn necessitates a contraction in lending activities to bridge funding gaps. Statistics from the China Foreign Exchange Trading Center reveal that the scale of purchased resale assets decreased by 2.09 trillion yuan year-on-year in January 2025. Notably, the daily average funds released plummeted from 40 trillion yuan at the end of the previous year to approximately 20 trillion yuan.
This "balance sheet shrinking" intensifies the liquidity strain within the interbank market, pushing money market rates ever higher. The earlier mentioned bank representatives have elaborated on this development, clarifying that the tightening of liquidity further exacerbates the already existing challenges faced by financial institutions.
As notable factors converge, banks are reporting tight levels of unutilized capital. According to analysts, the excess reserve rate had already dipped to 0.93% by the end of January—a significant drop from the previous month. Predictive models warn that considering the net withdrawal of 1.5 trillion yuan from the central bank’s open market operations as well as 500 billion yuan in government debt payments, the excess reserve rate could fall to as low as 0.52%. This figure is considerably below the established industry safety threshold of 1%, indicating a potential risk for payment settlement if 1.3 trillion yuan in liquidity is not injected swiftly.
Multiple dimensions contribute to this mounting pressure on the bank liability landscape. The financial system is experiencing a multifaceted withdrawal of base currency through various channels. Current sources indicate that fiscal deposits have seen massive capitulations, alongside an estimated 800 billion yuan departure from the banking system attributable to seasonal cash movements associated with the Lunar New Year.
Due to the self-regulatory guidelines on non-bank deposits, large banks are experiencing greater funds outflow than smaller counterparts; however, small banks are grappling with their own stability issues stemming from persistent reductions in municipal fiscal deposits. Representatives from regional commercial banks have reported a pronounced shrinkage in the share of fiscal deposits.
Recent data released by the Ministry of Finance revealed a 12.2% year-on-year decline in local government fund revenues for the year 2024. Contributing factors, such as reduced land transfer pricing and fiscal reallocations, have undermined the financial foundation of local commercial and rural banks.
Additionally, the expedited issuance of government bonds is exerting further pressure. According to figures from Wind, net financing for governmental bonds is projected to reach an unprecedented 1.8 trillion yuan in February—a record single-month high. Analysts caution that while early bond redemptions could alleviate local debt pressure, the concentrated payment schedules are straining the liquidity of the banking sector, engendering a negative feedback loop characterized by "fiscal collection leading to bank resource depletion."
Moreover, regulatory policies surrounding non-bank deposits, in conjunction with rectifications in interest compensation, have led banks facing deposit outflows to pivot towards issuing interbank certificates of deposit. The ongoing trend has seen 40 banks announce their respective deposit issuance plans for 2025, with total issuance overtaking 10 trillion yuan as of February 20. Among these, China CITIC Bank leads the pack with a colossal 1.48 trillion yuan issuance, with notable increases reported by Jiangsu Bank and Beijing Bank among other city commercial entities.
This wave of issuance can be traced back to the end of 2024 when several state-owned banks, such as Agricultural Bank of China and China Construction Bank, moved to boost their deposit caps significantly. In light of a liquidity deficiency exceeding one trillion yuan this February, the central bank has notably refrained from any rate cuts or reductions in reserve requirements. On February 20, the People’s Bank of China announced that the LPR would remain steady, with no changes to the one-year and five-year rates.
As per the analysis provided by chief economists, banks are currently navigating significant interest margin pressures. Post-holiday credit demand has shown signs of recovery, yet restrictive open market operations from the central bank have placed further constraints on banking liabilities, diminishing banks' motivation to lower LPRs or reverse repo rates. Concurrently, the initiated process of monetary easing from the Federal Reserve has slowed, maintaining offshore renminbi rates near the 7.3 mark after the holidays concluded. The promising condition of credit in early 2025 further dilutes the immediacy surrounding LPR rate reductions, revealing a measured approach by policymakers.
Looking ahead, the fourth quarter monetary policy report for 2024 reiterated the stance of "moderate loosening," while also emphasizing the diverse array of tools available to the central bank for macroeconomic regulation, including interest rates and reserve requirements. There exists a clear indication that the People’s Bank of China remains committed to a lenient monetary policy posture, hinting at potential for future LPR easing alongside reverse repo reductions, and all eyes are now on the forthcoming Two Sessions and the subsequent policy directives they will herald.