Will the Reprieve for China’s Lenders Last?

Chinese yuan coins on China's flag
Datacraft | Getty Images
Chinese yuan coins on China's flag

China's central bank has said it is ready to help out local lenders suffering under tight credit conditions, but that doesn't mean the reprieve for banks will last long, analysts say.

The People's Bank of China (PBOC) said on Tuesday it would guide market rates to reasonable levels and expected seasonal factors that have contributed to a spike in interbank lending rates over the past two weeks to gradually ease.

Still, the central bank has made it clear that it wants local lenders to rein in the high credit growth that poses risks to financial stability. That means banks will continue to feel some pain even as credit conditions ease up over the short-term, China watchers said.

"The PBOC is taking away the punch bowl, Chinese style. The party has been on in the non-banking system and they don't want it to get out of control," Thomas Byrne, senior vice president at credit ratings agency Moody's Investors Service, told CNBC Asia's "The Call."

(Read More: China Is Right to Tame Credit Growth: Moody's)

Fears that China's credit squeeze will lead to slower economic growth and raise the risk of a crisis in the banking sector have roiled markets inside and outside China this week.

Assurances from the PBOC that it would offer funds to banks if needed helped most Asian stocks rebound on Wednesday. But China's equity market continued to fall with small and mid-sized lenders, seen as more dependent on short-term interbank funding than larger banks, hurt the most.

Ping An Bank for instance fell 2 percent, while China Minsheng tumbled 3.5 percent.

(Read More: Goldman Sees No Rebound for Chinese Stocks)

"Lots of Chinese banks are trading at a price-to-book ratio of less than one," said David Marshall, senior analyst, Asia-Pacific financials, at research firm CreditSights, referring to a ratio that compares a company's stock market value to its book value. "Clearly that indicates that there are worries about the future profitability of the Chinese banks."

Shaking the Tree

Short-term lending rates in China's money markets hit record highs last week, with the key seven-day repo rate rising above 10 percent. The PBOC meanwhile has deliberately avoided pumping significant amounts of cash into the system in a bid to force local lenders to rein in credit growth which has reached worrying levels.

"They've kind of seen who's vulnerable in terms of the liquidity profile; who has been the most exposed to gaining liquidity through unregulated measures," said Timothy Riddell, head of global markets research for Asia at ANZ Bank. "So they've shaken the tree there and given an indication of where they need to watch for problems."

Money market rates in China remain at high levels, with the seven-day repo rate standing at around 7.2 percent on Thursday. It had hovered between 2 percent and 4 percent for most of the year until credit conditions started to tighten earlier this month.

"The new leadership does look like it is willing to take tough action and is determined to slow down credit growth," said CreditSights' Marshall. "In the short-term there will be some pain, slower growth which will give rise to asset-quality problems that could come to the fore," he added.

— By CNBC.Com's Dhara Ranasinghe, Follow her on Twiiter:@DharaCNBC