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China central bank squeezes banks—but not so much

Friday, 25 Oct 2013 | 4:12 PM ET
A man walks past the People's Bank of China headquarters in Beijing.
Tomohiro Ohsumi | Bloomberg | Getty Images
A man walks past the People's Bank of China headquarters in Beijing.

The Chinese central bank appears to be putting the squeeze on its nation's financial institutions again—though not as sharply as it did last summer, when a reduction in liquidity caused international markets to swoon for several days on fears the world's second-largest economy was on the verge of a banking crisis.

Several Chinese newspapers reported that the seven-day Shanghai Interbank Offered Rate, or Shibor, surged 69 basis points to 4.68 percent, and appears to have moved higher on Friday as well—marking a three-month high. The Shibor is an average, modeled after London's Libor, of all yuan-lending rates offered by Chinese banks with a good credit rating.

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Still, it is far lower than the levels seen in late June and July, when it climbed to above 12 percent.

China continues its tightening trend
Matthew Plan, analyst for Asia-Pacific banks at CreditSights, explains that by launching a market-driven benchmark lending rate, China is continuing to tighten its monetary policy.

The central bank also appears to be withdrawing liquidity via a reduction in reverse repos, a mechanism to increase or decrease the money supply in the banking system. For at least three days in a row, the People's Bank of China did not conduct any reverse repo operations—causing 58 billion yuan ($9.5 billion) to be removed from the system this week, on top of 45 billion last week, according to Chinese media.

The moves may be in response to recent inflation and housing-price data which have shown increases despite the central government's attempts to slow down both, especially the housing market.

(Read more: Shanghai shares fall to lowest in a month)

In a related event announced on Friday, China has launched a benchmark lending rate for the first time. Reports indicate that it will be used to guide commercial banks on what rate to set—something Chinese bankers aren't accustomed to doing, because up until very recently lending rates have been controlled by the central government, not the market.

"Leaders in Beijing have repeatedly signaled that they are serious about fundamental economic policy reforms in 2013, including interest rate reform," said Dan Rosen of Rhodium Group. "They are now implementing those commitments."

So far however, the government still controls deposit rates—a key factor in what seem to be ever-rising real estate prices.

The government imposes a ceiling on the interest rates that banks are allowed to pay depositors; currently, it's capped below the rate of inflation and as a result, depositors are tempted to seek higher returns elsewhere—such as in real estate.

By CNBC's Michelle Caruso-Cabrera. Follow her on Twitter @MCaruso_Cabrera.

Contact World Economy

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