China banks undergo deleveraging as tight liquidity persists

But it's still in a nascent stage.

The authorities have made preventing financial risks their top priority. Analysts at UOB Kay Hian observe that the tightening of liquidity has led to deleveraging in the banking sector although it is still in a nascent stage. China Everbright Bank has raised capital through convertible bonds and placement of new H-shares. Shanghai Pudong Development Bank has trimmed available-for-sale financial assets and investments in receivables. 

Here's more from UOB Kay Hian:

Financial risks in the crosshairs. The authorities have emphasised the focus on preventing financial risks since the National People’s Congress in Jan 17. This is a priority agenda initiated by the upper echelon of political leadership in China. The authorities have the resolve to remove excessive leverage and regulatory arbitrage in the financial services sector.

Expect tightness in liquidity to continue. Many investors believe that the authorities would ease the tightness in liquidity in 4Q17 after the 19th National Congress in September. Similarly, they argued that the pattern seen in 2013 would repeat when the authorities aggressively tightened liquidity (lasted only one month) but subsequently relented and injected liquidity.

We beg to differ. We believe the authorities are resolute in their determination to eradicate risks and leverage in the financial system. We expect the current tight liquidity to persist for a considerable period of time so as to ensure that deleveraging progresses gradually over time but does not cause unnecessary disruption to growth in the broader economy. Easing too soon would encourage smaller banks to revert to their previous risk-seeking habits.

Unwinding of investments funded by interbank borrowings. The PBOC has increased banks’ cost of liabilities through interventions in the money markets. The 3- month SHIBOR has increased from 3.27% at Dec 16 to 4.39% in Mar 17. It hit a peak of 4.78% in mid-June and eased slightly to 4.55% currently. The higher cost of liabilities removes the incentive for banks to utilise interbank borrowings to invest in huge portfolios of government and corporate bonds.