On February 18, the People's Bank of China (PBOC) took significant steps to manage liquidity in the financial system by conducting a reverse repurchase (reverse repo) operation of 489.2 billion yuan with a fixed interest rate of 1.5%. This maneuver was implemented to tackle the liquidity pressure arising from the expiration of 500 billion yuan in medium-term lending facilities (MLF) on the same day, as the central bank aimed to ensure that the banking system remained adequately funded.

Since the start of the year, there has been a noticeable decrease in the amount of funds lent by banks, while money market funds and wealth management products have maintained a stable level of financingAs a result, the structure of the market's liquidity is undergoing a transformationExperts in the financial sector indicate that various factors, such as government debt issuance, tax payment periods, and the maturity of MLFs, may lead to a “tight balance” in liquidity, even though potential reverse repo operations might offer some support to overall liquidity conditions.

The PBOC's decision to increase its reverse repo operations in light of substantial MLF expirations underscores its agile and forward-thinking approach to liquidity managementA seasoned market analyst explained that reverse repos allow the central bank to inject short-term funds into the market, alleviating the pressure from MLF expirationsThis strategy is critical to prevent the market from becoming overly tight, thus ensuring that the banking system has reasonable access to liquidity.

“When MLFs expire, it signifies a withdrawal of long-term funds, while the reverse repos provide short-term fundsThis dynamic shifts the maturity structure of available funds, resulting in a higher proportion of short-term funds compared to long-term fundsSuch a fluctuation might slightly lower the overall stability of market liquidity,” the analyst noted.

Despite the PBOC's substantial reverse repo operations supporting the markets, liquidity throughout February 18 remained strained, as evidenced by the upward trend in the weighted average interest rate of DR007, which increased by 28.8 basis points to 2.3447% by the end of the trading day.

The liquidity landscape has showcased new characteristics since the beginning of 2024. Prior expectations suggested that post-Spring Festival demand for cash by residents would decrease and that the lighter tax burden in February would lead to a more relaxed liquidity environment

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However, continuous large-scale net withdrawals of liquidity by the central bank have led to a generally tighter liquidity situation, defying earlier assumptions.

“In the past, banks would typically lend funds to non-bank financial institutions; now it appears that non-bank institutions are lending to banks,” remarked a bond trader, highlighting the shift in the lending landscape.

The core reason for this tightening continues to stem from pressure on banks’ liabilitiesThe latest financial data released by the PBOC indicates that non-bank deposits plummeted by 1.11 trillion yuan in January, which is a stark year-on-year drop of 1.66 trillion yuan, implying that the outflow of non-bank deposits continues unabated.

Xiao Jinchuan, a fixed-income analyst at Huaxi Securities, pointed out that since the self-regulatory guidelines for interbank deposit rates among non-bank institutions were announced at the end of November 2024, non-bank deposits have collectively decreased by 4.1 trillion yuan—a year-on-year plunge of 5.7 trillion yuanThis persistent outflow of deposits has heightened the stress on bank liabilities, coupled with tendencies for tighter regulatory oversightConsequently, lending via repos by banks has dramatically decreased, plummeting from a daily average of 4 trillion to 5 trillion yuan towards the end of last year to below 1.5 trillion yuan currently.

These shifts indicate also a new characteristic in the funding structure, where non-bank institutions appear comparatively more solvent than banksWang Menghan, a fixed-income analyst at Zheshang Securities, noted that the significant decrease in fund loans from the banking system may reflect banks' strategies to prepare for upcoming MLF maturities, repurchases, and tax obligations.

Conversely, the financing levels of money market funds and wealth management products have remained relatively stableAccording to Wang, these vehicles, primarily focused on short-duration assets, continue to provide funding amid fluctuating supply and demand conditions, with their available funds maintaining a level around 2.7 trillion yuan.

“Since the start of the year, the scale of lending from major banks has decreased by 3.1 trillion yuan

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