Chapter 5
Interbank Borrowing, Lending, and Bonds

1. The Process of Development

2. The Rules for Market Operation

3. A Survey of Market Transactions

1. The Process of Development

At present the interbank market in local currency is composed of the borrowing and lending market and the bonds market. Financial institutions adjust asset-liability structure, make investments, and conduct the management of financial affairs by using the interbank market control monetary position through such channels as credit borrowing and lending, bond repurchase (including collateral repurchase and buyout repurchase), the trading of bonds, and the forward transaction of bonds.

The interbank market is the core of the financial market system with the character of wholesale trading. The indices of the inter-bank market cover the borrowing and lending interest rate, bond repurchase, and bond yield. They are the basis for the pricing of other financial products and derived instruments and an important weathervane upon which a macro-control decision is made. Transactions in the interbank market in local currency include two parts: the electronic transaction system and off-system transactions. The transaction volume of the electronic system accounts for over 90% of the entire interbank market transactions in terms of credit borrowing and lending, repurchase of bonds, or the trading of bonds. Being able to join the electronic transaction system and become a member of the interbank market is a sign of competitiveness for financial institutions.

1.1 The Credit Borrowing and Lending Market

Credit borrowing and lending refer to the short-term financing between financial institutions with their respective credit as guarantee, and the market thus formed is the so-called credit borrowing and lending market, or borrowing and lending market for short. The interbank credit borrowing and lending in China began in 1984, and has since experienced many ups and downs. In early 1996, the PBOC decided to set up the National Interbank Funding Center on the basis of the China Foreign Exchange Trade System (CFETS). Both the China Foreign Exchange Trade System and the National Interbank Funding Center were under the control of one legal entity, and the leadership of one management team, yet they had two signboards. On January 3, the credit borrowing and lending electronic trading system went into operation, signifying the birth of the unified national interbank borrowing and lending market in China. The development of the interbank borrowing and lending market in China can be divided into the following four phases.

The 1984–1992 phase features natural development. In 1984, when the PBOC functioned as the central bank, other specialized banks such as the ICBC, ABC, BOC, and CBC conducted capital operations independently and financing between specialized banks gave rise to the interbank borrowing and lending business. With the establishment of non-bank financial institutions such as trust companies and financial companies, the interbank borrowing and lending business developed steadily. The PBOC offered strong support and encouragement to the interbank borrowing and lending business during this period. However, due to limited understanding of the business, both management and operation were not standardized. The local governments’ administrative intervention, in particular, resulted in vicious development of the short-term borrowing and lending business. The borrowing and lending were invested in the stock market and real estate industry, and acts of illegal fund-raising, borrowing, and lending were rampant. In 1993, the PBOC began to straighten out the borrowing and lending market.

The 1993–1995 phase features a loose development with a focus on the regional interbank borrowing and lending business. In 1993, with the setting up of financial centers across the country, regional interbank borrowing and lending markets emerged and developed until January 3, 1996, when a unified national interbank borrowing and lending market was established. During this period, the business volume of interbank borrowing and lending rose rapidly and the rise of financial centers relying on the PBOC played a decisive role in enlivening the market. The PBOC managed to meet the financing demands between financial institutions by conducting direct interbank borrowing and lending business through financing centers. However, this method was in conflict with the function of the PBOC as the central bank and the financing centers took over a large amount of overdue fund in various capital markets carried over from before 1993, resulting in a great pressure.

The 1996–1998 phase witnessed the formation of unified national interbank borrowing and lending market. On January 3, 1996, a national interbank borrowing and lending market was formed. However, local financing centers still played a role in the borrowing and lending transactions. At this phase, with the overall winding up and rectification of the financial centers, the business volume of borrowing and lending dropped by a big margin. After financing centers exited from the interbank borrowing and lending market, the unified national borrowing and lending market was formed in its true sense.

From 1999 through today, the unified borrowing and lending market has developed steadily. In 1999, with a rationalized market relationship in place, transactions began to recover gradually and grow quickly. The transaction volume kept rising and the market size expanded gradually. The main market players grew steadily in variety and quality and the function of the borrowing and lending system was further improved.

Legal entities of financial institutions, and their authorized branches with the qualifications for interbank borrowing and lending business, may engage in the credit interbank borrowing and lending business. Financial institutions can engage in credit interbank borrowing and lending business through the electronic trading system of the Trade System, or make a deal off the trading system. The financial institutions, which join the electronic trading system of the Trade System, are members of the Trade System and are subject to the approval of the PBOC. The financial institutions making a deal off the system are usually those with small business volume and low frequency, and they must report their transactions to the local branches of PBOC for records. In the process of borrowing and lending by the recording system, market information can be obtained from the China Currency Net of the Trade System in addition to making quotations and keeping electronic records.

Financial institutions first have to obtain the approval of the PBOC for joining the interbank electronic trading system. After this, the financial institutions apply to the Trade System for networking and send salespersons to the Trade System to receive training as traders. After networking to the electronic trading system is completed, trading can be done in the interbank borrowing and lending market. In the process of trading, financial institutions can quote through the electronic trading system independently, make formatted inquiry of other members, and conclude a deal after final confirmation. The transaction advice printed by the trading system is a contractual document with legal effect that confirms a deal between financial institutions. Both parties make settlements through the payment system in line with the advice on the principle of independent settlement with each party assuming its own risks.

To ensure a healthy and orderly development of the borrowing and lending market, the PBOC carries out strict examination of the market access and sets forth the loan size and length of maturity for each type of financial institution. The Trade System can convert the regulatory requirements of the PBOC to electronic monitoring through the electronic trading system to ensure that its members do not go against the requirements, and provide facilities for financial institutions to avoid the risks brought by policies and systems.

The indicator of borrowing and lending interest rate generated in the electronic trading system is called CHIBOR. CHIBOR is the weighted average interest rate of each transaction variety for credit borrowing and lending released by the National Interbank Borrowing and Lending Center at the end of each business day. Its generation mechanism is as follows: with the turnover of each deal as the weight, the weighted average interest rate of each variety traded on the same day and the weighted average rate of each variety are calculated. CHIBOR is now made of the interest rate indicators of eight varieties, such as one day, seven days, 14 days, 21 days, one month, two months, three months, and four months. The credit borrowing and lending of members and financial institutions off the trading system can be realized through the local overnight borrowing and lending system, and the electronic recording quotation system, under the supervision of the PBOC.

1.2 The Bonds Market

The bonds market has two divisions: the repurchase market and the current bonds market. Conventionally, it is divided into the exchange market and the curb market. The exchange market is mainly for small and medium investors, and its trading method suits small business engagements. According to international experiences, bond trading focuses chiefly on the curb market as opposed to the exchange market, whereas the interbank bonds market is the main body and core of the curb market.

The bond repurchase business in China began in 1991. In order to increase the liquidity of treasury bonds, STAQ systems announced in July 1991 that it would handle treasury bonds repurchase trading on a pilot basis, and closed its first repurchase deal on September 14 of that same year. Afterwards, the T-bonds market developed rapidly, but due to poor market management and other reasons, many problems cropped up in the repurchase market. The trading form, the main players, and the capital use were nonstandard with too high an interest rate for the repurchase transactions. In view of this, the PBOC, the Ministry of Finance, and the CSRC jointly issued a notice to standardize the repurchase business, and thus the repurchase market began to be rectified on August 8, 1995. Also, after the implementation of a series of rectification measures, the curb exchange was basically contained, disorder in the repurchase market remarkably decreased, and the repurchase market got back on the track of normal and healthy development.

To meet the requirements for interbank trading and improve the bonds market system in China, the PBOC decided to draw upon its previous experience in building the interbank borrowing and lending market, and established the interbank bonds market in early 1997. On June 16, 1997, in line with the plan of the PBOC, the Trade System presented the bond electronic trading system to the financial institutions, signifying the founding of a unified national interbank bonds market.

The interbank bonds market deals in four transactions: bond trading, bond collateral repurchase, bonds buyout repurchase, and bond forwards. The bond trading and bond collateral repurchase transaction systems were launched on June 16, 1997. The buyout repurchase system was introduced on May 20, 2004, and the bond forward transaction system on June 15, 2005. Exchangeable bonds in the interbank bonds market refer to the book entry securities, such as government bonds, policy-based bonds, instruments of the central bank, financial bonds, junior bonds, corporate short-term financing bonds, securities company’s short-term financing bonds, and corporate bonds that can be traded in the interbank bonds market with the approval of the PBOC. With the continuous development of the bonds market, the variety and type of bonds on sale have kept on increasing. For a time, the interbank bonds market implemented an examination and approval system. The financial institutions that had joined the electronic trading system and become members of the bonds market had to apply to the PBOC for approval. In April 2002, the PBOC abandoned that examination and approval system for a filing system. With the filing system, financial institutions can join the interbank bonds market as long as they have the qualifications for bond or portfolio investment, and submit relevant documents to the National Interbank Funding Center and the Central Treasury Bonds Registration & Settlement Company for filing purposes.

To join the interbank electronic trading system, financial institutions have to send salespersons for training as traders in the Trade System, and apply for network access after they pass the filing examination. Bond trading can be done after network access is established to the electronic trading system. In terms of transactions, financial institutions can make a deal by quoting independently through the electronic trading system, making a formatted inquiry of other members, and obtaining final confirmation. The transaction advice printed by the trading system is a contractual document that confirms a bond deal concluded between financial institutions. Both parties make the bond delivery through the bond registration system and settle accounts through the payment system in line with the content in the advice on the principle of independent settlement, with each party assuming its own risks.

To cater to the need for the development of the bonds market, the Trade System introduced a new trading system in early 2003, with trading facilities such as petty quotation on the basis of inquiry transaction. Petty quotation is a one-way go-between facility for direct transactions to be made in a given condition without making inquiries.

The bond trading system generates the bond index each day and the repurchase interest rate indicator system, which includes the collateral repurchase and buyout repurchase rates. The repurchase interest rate indicator system shows the repurchase weighted average rate of each variety, and its generation mechanism is similar to that of CHIBOR, a weighted average rate calculated using each transfer quantity of every variety as the weight. The current collateral repurchase interest rate system is composed of 11 varieties and buyout repurchase of seven varieties. Due to small risks and large business volume of the bonds repurchase market, the repurchase interest rate system has gradually acquired the characteristics of a short-term interest rate base.

Transaction members have to quote the initial transaction price of bonds and transaction price at maturity in the buyout repurchase business. As the repurchase interest rate is a reference rate calculated on the two prices, the trading system can also provide for the buyout repurchase the quotations of net prices for the initial and mature transactions of each bond variety traded.

To cater to the need for the development of the bonds market, especially current bond transactions, the Trade System drew on its experience in formulating the world-famous bond index, and introduced the Interbank Bond Index on June 10, 2002. This index is made up of the Interbank Treasury Bond Index, representing the market base and Interbank Bond Composite Index representing the overall price trend in the market. At present, the index specimen of the Treasury Bond Index only includes the fixed rate treasury bonds circulated in the interbank bonds market. The purpose is to provide the market with one indicator, with one-year risk-free bonds as the benchmark for the return of risk-free bonds. The index specimen of a composite index covers all the treasury bonds, financial bonds, and corporate bonds with both fixed rates and floating rates that are circulated in the interbank bonds market. The aim is to provide the market with one indicator for the reward of over one-year integral bonds, which can really represent the value of the integral bonds market, and simultaneously serve as the base for the return of the integral bonds market. As an indicator of fluctuations in the bond price, the interbank bond index provides a basis for the market research and forecasting. It is also a standard for assessing investor’s performance and can help financial regulatory institutions obtain overall information about the bonds market.

2. The Rules for Market Operation

2.1 Interbank Borrowing and Lending in RMB

When a mode of inquiry transaction is carried out for any quotation confirmed by a member, the trading system automatically issues a transaction advice as the valid voucher for the deal concluded between both parties.

Both parties of the transaction can decide on the borrowing and lending duration through negotiation within a period of four months. The Trade System calculates and publishes the weighted average rate, namely, CHIBOR, in terms of eight varieties. This includes rates for one day, seven days, 14 days, 21 days, one month, two months, three months and four months. The transaction occurs from Monday to Friday (Beijing time), 9:00 a.m. to 12:00 noon and 13:30 to 16:30 (closed on public holidays in China).

The main participants of the borrowing and lending transactions in RMB include relevant financial institutions, such as commercial banks and their authorized branches, rural credit associated cooperative, urban credit cooperatives, financial companies, and securities companies with an independent legal entity status approved by the PBOC, as well as foreign-funded financial institutions permitted by the PBOC to conduct the RMB business.

Both parties of the deal make full settlement of funds in line with the transaction advice and specified date, with each party assuming its own risks. The fund settlement speed is T+0 or T+1.

2.2 Transaction of RMB Bonds

Transactions of bonds cover current bonds, bond collateral repur-chase, bond buyout repurchase, and bond forward transactions. Bonds used for bond transaction include treasury bonds, policy-based financial bonds, instruments of the Central Bank, junior bonds of commercial banks, short-term financial bonds, corporate bonds, and asset support securities.

The time limit for the collateral repurchase is one day to one year, and the trading system counts and publishes the business volume and price of the transaction for the collateral repurchase in terms of 11 varieties. These varieties include one day, seven days, 14 days, 21 days, one month, two months, three months, four months, six months, nine months, and one year. The time limit to the buyout repurchase is from one to 91 days, and the trading system counts and publishes the business volume and price of the transaction for the buyout repurchase in terms of seven varieties, including one day, seven days, 14 days, 21 days, one month, two months, and three months. The time limit to the bond forward transaction is from one day to 365 days, and the trading system counts and publishes the business volume and the price of the transactions for the bond forward in terms of 11 varieties, including one day, seven days, 14 days, 21 days, one month, two months, three months, four months, six months, nine months, and one year.

The transactions occur from Monday to Friday (Beijing time) 9:00 a.m. to 12:00 noon and 13:30 to 16:30 p.m. (closed on public holidays in China).

Starting from April 2002, a filing system has been implemented for access to the bonds market. According to this system, deposit financial institutions with the qualifications for bond transaction and their authorized branches, rural credit associated cooperatives, urban credit cooperatives, non-financial institutions such as insurance companies, securities companies, and fund management companies, and along with their fund and financial companies, as well as foreign-funded financial institutions conducting RMB business, can transact in the market.

Both parties of the transaction make full settlement of funds in line with the transaction advice and specified date. Custodian settlement of bonds is made through the Central Treasury Bond Registration and Settlement Company, and the fund settlement is made through the PBOC payment system. Three methods of payment are used, namely, Payment against Bond, Bond against Payment, and Delivery versus Payment (DVP).

2.3 Organizational Structure of the Market

The interbank market is composed of the regulatory institution, the foreground for trading, the background for settlement, the background for liquidation, and transaction members. The PBOC is the regulatory institution in charge of formulating development plans and administrative regulations, exercising supervision and control over the market, as well as standardizing and promoting market innovations.

The National Interbank Funding Center is an intermediary organization which provides the interbank market with three major platforms for transaction, information, and regulation. It also provides appropriate services by relying upon the trading system, the information system (China Currency Net), and the market analysis and risk management system (F-system). More specifically, it trains market traders, organizes market participants to engage in trading through the Internet, is responsible for the operation maintenance and development of the trading and information systems, conducts routine monitoring of the market transactions, discloses information necessary for the market transaction, provides the PBOC with a full range of market supervisory service facilities and basic information, actualizes relevant policies and measures for market administration, and ensures healthy and orderly market transactions.

The Central Treasury Bonds Registration and Settlement Company is one of the background organizations of the interbank market in charge of bond custody and settlement. To join the bond transaction in the interbank market, financial institutions must open a custody account with the company in advance. After a transaction member finishes a bond transaction in the foreground, it must transfer the relevant factors of the transaction to the bookkeeping system for bond settlement.

The Settlement Center is the public institution of the PBOC in charge of the operation of the electronic payment system and is another major background organization of the interbank market. When a transaction member finishes bond trading or credit borrowing and lending in the interbank market, it has to make fund settlement through the payment system.

2.4 The Basic Function of the Market

With the diversification of the main participants in the interbank borrowing and lending market, the bonds market, and the expansion of products range, the transfer volume in the market has grown year by year and the liquidity of the interbank borrowing and lending market, as well as the bonds markets, continues to rise rapidly. The liquidity management function of the market, has been enhanced. The transfer quantity within less than seven days of the interbank borrowing and lending, and collateral repurchase, is the cornerstone of the whole market, and accounts for over 80% of the total quantity. The introduction of the buyout repurchase business into the inter-bank bonds further increases the market liquidity. Many financial institutions with good market operational performance have therefore significantly reduced their excess provision in the PBOC, and operated idle funds in the interbank borrowing, lending, and repur-chase market for a higher return. Moreover, the CHIBOR rates of the interbank borrowing, lending, and repurchase market have gradually become an important reference for the cost and income accounting between the head office of a legal entity and its branches, the marginal factor for the investigation of other relevant businesses, and the main basis for the pricing of short-term funds across the country.

Meanwhile, the diversified bond variety, improved internal incentive mechanism for institutional investors, and upgraded traders’ market operation have enabled the interbank bonds market to gradually play a role of investment, and investors, good at grasping opportunities, have earned considerable profits. This is especially true of medium- and long-term bonds, the reduction of interest rates, and the combination of the bond business with other businesses. After several years of extraordinary development, the function of the interbank bonds market has shifted from pure liquidity management to the combination of liquidity management and investment.

At the same time, the interbank borrowing and lending market and the bonds market constitute a platform for immediate market supervision by the regulatory institution. It can provide the monetary policy department with necessary information concerning the implementation of monetary policies, such as trends of capital flow. Furthermore, the interbank borrowing and lending market, as well as the bonds market, are a major link in the transmission mechanism of monetary policy.

2.5 Market Access

The borrowing and lending market differ somewhat from the bonds market with regards to their market access. Any financial institution, or its authorized branches with interbank borrowing and lending business or securities business indicated in their business licenses, can apply to the PBOC to join the national interbank funding market or the national interbank bonds market through filing. After approval, they can immediately become members of the interbank market. Interbank market transactions can be effected after the training of traders in the Trade System, and networking to the electronic trading and information systems.

Financial institutions applying to join the national interbank bonds market must submit the following materials to the Trade System:

• A photocopy of their business license.
• Photocopies of relevant financial business licenses, including the license of financial institutions, the license of trust institutions, securities business license, and insurance business license.
• For commercial banks, the letter of authorization for bond transaction by their head offices.
• The application form for connecting to the trading system of the National Interbank Funding Center.

A financial institution cannot become a member of the national interbank bonds market until after the above materials have passed the examination of the Trade System and a bond custody account is opened with the Central Settlement Company. A financial institution must file a record with the PBOC within three working days after going through the formalities of networking and account opening.

3. A Survey of Market Transactions

By the end of 2005, exactly ten years after its founding, the local currency market of the Trade System had achieved an accumulated number of 426,959 deals, amounting to RMB 74.84 trillion. From 2000 onwards, the local currency market grew rapidly and, in 2005, the annual turnover stood at RMB 23.21 trillion, nearly 40 times that of 1996 when the market was set up. On February 9, 2006, the PBOC issued a notice on launching pilot projects for the RMB Interest Rate Swap Transaction. As the first RMB interest rate derivative, the interest rate swap has met the urgent needs of investors in the interbank bonds market for risk management of interest rates and asset-liability management, as well as accelerated the pilot deregulation of interest rates aimed to make them subject to market forces. Up to March 31, 2006, there were 18 institutions that had filed within the system, and seven deals had been recorded with a total nominal principal of RMB 9.51 billion.