By Gabriel Wildau and Samuel Shen
SHANGHAI (Reuters) - China's central bank is squeezing funds out of the money market, forcing banks to borrow money at historic interest rate levels, but the manoeuvre appears to have been calculated to have limited impact on the real economy.
Economists warn that a broader crackdown on so-called shadow banking, and the central bank's commitment to preventing a debt blowout, will raise borrowing costs and reduce the flow of credit to the already slowing Chinese economy in the medium-term.
But bankers say the credit squeeze is not seriously impeding corporate lending for now because their ability to lend to companies is determined by the amount of deposits they hold rather than short-term lending rates in the wholesale market.
Reports have circulated in China's domestic media this week that major domestic banks had temporarily suspended lending operations amid a spike in the interest rates that banks charge each other for short-term cash.
While some banks confirmed a lending halt in recent days, they said it was due to adjustments following a sharp rise in new lending over the past few weeks.
"I don't see any direct linkage with the interbank cash crunch. At the end of each quarter, it's natural for banks to compete for deposits and the diversion of deposits would force some banks to stop lending," said a loan officer at a Shanghai branch of Bank of China <1398.HK> <601398.SS>.
"Lending would often be resumed at the start of July," added the officer, who declined to be identified because he is not allowed to speak to the media.
This disconnect between interbank borrowing conditions and the flow of loans to main street businesses could be why authorities are allowing the liquidity squeeze to rage.
In a dramatic statement released on Tuesday night, in which the People's Bank of China disclosed that it had provided extraordinary support to individual banks that were short of cash, the central bank began by observing that "the functioning of China's economy and financial system is generally stable".
In the first half of this month China's "Big 4" state-owned lenders had issued more loans than for all of May according to local media reports, likely maxing out their unofficial monthly lending quotas.
China Construction Bank <0939.HK> <601939.SS> President Zhang Jianguo said on Thursday the bank had not stopped issuing new loans despite tightening in credit.
Total social financing, a broad measure of fundraising in the economy that includes bank loans, bond issuance and some forms of off-balance-sheet financing, missed expectations in May but was still up 52 percent year-on-year in the first five months of 2013.
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Shang Fulin, chairman of the China Banking Regulatory Commission, told an industry meeting last week that banks should "prevent the self-circulation of funds" within the banking system and "ensure that credit funds flow into the real economy".
Shang's remarks appeared to refer to explosive growth in banks' interbank business.
Interbank assets at Chinese banks rose 132 percent from 2009 to 2012, compared to a 51 percent increase in total assets, according to estimates by Michael Werner, senior banking analyst at Bernstein Research.
In some cases, complex round-trip transactions between banks allow them to generate income and meet internal targets for balance sheet growth, even as funds never leave the banking system.
Officials are especially concerned to staunch the flow of credit to the vast shadow banking sector, where many of China's riskiest borrowers have migrated in search of funding.
In some cases, banks have used short-term interbank funding to raise cash for payouts of structured products based on illiquid, long-term assets.
The government has introduced a series of measures to curb such activities in recent months.
That campaign will likely push up financing costs for businesses and local governments, leading to slower growth, but analysts say the effect will take time.
"An improvement in market sentiment and drop in interbank rates do not mean a reversal of macro and monetary policies. Over the coming months, we expect credit growth to slow and financing costs in the economy to rise," Wang Tao, head of China research for UBS, wrote in a note on Thursday. (Additional reporting by Shanghai newsroom; Editing by Kazunori Takada and Alex Richardson)
