Credit squeeze pushes up interbank lending rates

Overnight interbank rates have been alarmingly high the past few weeks. Despite the cash crunch, on Thursday, the PBOC surprised the market and instead issued 2 billion yuan worth of bills which drains liquidity from the markets. Following that move, interbank lending rates surged across the board.

A market panic spread as the central bank sold 2 billion yuan of three-month bills, and rumours circulated that a state-owned bank defaulted. The overnight interbank market rate and the 7-day repurchase rate both hit record highs on Thursday.The benchmark Shanghai Interbank Offered Rate jumped significantly over the past few weeks, highlighting the liquidity squeeze in the world's second-largest economy. Despite a moderate fall on Friday, the rate is still lingering at a high level.

The central bank has paid 6.5 percent for 40 billion yuan of six-month deposits from the Finance Minister at an auction, which is considered as a "wholesale" capital injection to financial institutions. It's expected that such a move could help ease liquidity tensions in the market, but the amount is inadequate. Experts say Chinese financial institutions are overly dependent on the central bank to inject capital and reduce lending rates, suggesting management should be more market-oriented.

As banks are thirsty for money, prospective earnings of their financing products have gained a lot recently. Analysts believe the yields will continue to rise in the short run, but will hold steady in the second half of the year.