Is the CNH interbank spike indicative of a liquidity problem?

CNH market is still relatively small.

A spike in the Hong Kong interbank rate for offshore renminbi (CNH-Hibor) this week is not indicative of a broader liquidity problem in the Hong Kong banking system, says Fitch Ratings.

According to a release from Fitch Ratings, the impact on earnings for Hong Kong banks is difficult to assess, while it is unlikely to result in higher impairment charges - and some banks may even benefit in the form of increased interest and trading revenues.

The CNH market is still relatively small and there is only a limited risk of the rate spike having a significant direct impact on Hong Kong banks. The market is driven by deposits and banks' issuance of certificates of deposits, both of which are likely to decline if the unit depreciates.

Banks in turn hold their CNH in cash equivalents and securities and trade derivatives. The share of CNH lending, mostly trade related, has remained small as indicated by a loan-to-deposit ratio of below 30%. There are large market-making banks with big pools of CNH - including the major mainland lenders, HSBC, Standard Chartered, BNP Paribas and Citi - and Fitch believes they will continue to make it available to their clients.

Here's more from Fitch Ratings:

The jump in CNH-Hibor to above 60% was the result of the People's Bank of China (PBOC) buying offshore renminbi to tighten CNH liquidity in an effort to reduce short positions against the currency, according to media reports. This was also spurred by an increasing disconnect between the offshore (CNH) and onshore (CNY) exchange rates since the beginning of the year. The Hong Kong Monetary Authority noted increased usage of its CNY lines.

Nonetheless, the volatility seen in CNH-Hibor and the PBOC's intervention could raise questions regarding the credibility and sustainability of the renminbi's internationalisation more generally, and highlights the opaqueness of the CNH market and cross-border flows. As such, this could affect investor sentiment, especially at a time of increased capital market volatility and broader concerns regarding macroeconomic risk.

The PBOC's intervention is likely to support the CNH and act as a stabilising factor to slow the rate of depreciation versus the US dollar and Hong Kong dollar, although banks' usage of renminbi is likely to continue to focus on securities and bank placements. More profitable renminbi lending is still likely to grow only slowly, in line with the broader direction of the currency.

Fitch maintains stable sector and rating outlooks for Hong Kong banks. But the sector is vulnerable to slower growth in China, with China-related asset quality, in particular, being a key issue to watch. Loan-impairment charges are likely to rise this year with a potentially larger contribution from Chinese borrowers. System liquidity remains robust, though sudden withdrawals cannot be ruled out if sentiment towards China or the broader region were to change.