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MLF Reduces Volume Again as Funding Tensions Persist
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- July 6, 2025
In a decisive move to reinforce the liquidity of China's banking system, the People's Bank of China (PBOC) recently initiated a significant operation involving three thousand billion yuan in medium-term lending facilities (MLF). With a maturity of one year, the operation included a maximum bidding rate of 2.20%, a minimum rate of 1.80%, and a successful bid rate set at 2.00%. Following this maneuver, the balance of MLF stood at an impressive 40,940 billion yuanNotably, the MLF operation takes place against the backdrop of 5,000 billion yuan in MLF maturing on February 18, marking a net withdrawal of 2,000 billion yuan for the month of February.
The MLF serves as a crucial tool for the central bank in controlling market liquidity and mid-term interest rates, playing a vital role in influencing the financial environmentBy conducting MLF operations, the central bank essentially injects mid-term base currency into the market, thereby impacting the funding costs for financial institutions, which in turn affect the financing costs for the real economyThe recent smaller scale of the MLF operation reflects the central bank's cautious approach in regulating market liquidity and its comprehensive assessment of the current economic situation.
Since October of last year, the central bank has continued to reduce the scale of MLF operations while simultaneously engaging in open market purchases of government bonds and reverse reposThis strategic move has resulted in a net supply of medium and long-term funds each month, with a variety of terms, providing a flexible liquidity management toolGiven the current substantial MLF balance, analysts predict continued efforts to replace MLF with reverse repos, further diminishing the perceived significance of the MLF operation rates as policy rates.
Interestingly, the net withdrawal of MLF funds in February showed a significant decrease compared to the previous three monthsAccording to the chief economist at Minsheng Bank, Wen Bin, this shift demonstrates a rising demand among institutions for MLF amidst rapidly increasing market interest rates
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The central bank has exhibited a slight net injection of funds beginning on February 21, illustrating its supportive stance given the ongoing tight supply of capital.
Since mid-February, market liquidity has been characterized as relatively tightAs of February 25, the weighted average interest rate for a seven-day pledged repo in the interbank market was reported at 2.2161%, surpassing the central bank's policy rate significantlyConcurrently, the yields on one-year AAA-rated interbank certificates of deposit (CDs) have been climbing steadily, reaching 1.99% by February 25, which is markedly higher than the yields on ten-year government bondsFurthermore, there has been a notable increase in the issuance volume and net financing scale of interbank certificates of deposit.
In the context of a tighter financing environment, banks typically respond by increasing the issuance of interbank certificates of deposit to supplement their fundsAccording to Zhou Guannan, the chief analyst for fixed income at Huachuang Securities, the persistent tightness in the banking system has led to a phenomenon in the CD market characterized as "price increases for volume." This situation arises as banks, facing tighter funding conditions, raise the yields on CDs to attract investors and secure adequate funding.
The recent tightening of funds in the banking system results from a myriad of factorsOn one hand, tax payment periods compel enterprises and individuals to remit taxes to the central bank, leading to capital withdrawal from the marketThe substantial issuance of government bonds further contributes to this tightening effect by absorbing market liquidityOn the other hand, this situation reflects the central bank's stance on monetary policyWen Bin points out that the current focus of the central bank primarily revolves around stabilizing the exchange rate, mitigating interest rate risks, and preventing the phenomenon of capital idling
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Maintaining a tight balance in capital supply through open market operations aims to withdraw liquidity, ensuring that bond market interest rates and curves return to reasonable levelsFrom a macroeconomic perspective, stabilizing the exchange rate is crucial for international trade and capital flow; mitigating interest rate risks helps maintain stability in financial markets; and preventing the idle circulation of funds ensures that capital flows into the real economy, enhancing funding efficiency.According to Zhang Xu, the chief fixed income analyst at Everbright Securities, the current high financing rates are a reflection of the central bank's comprehensive consideration of various factors, where curbing the rapid decline in long-term bond yields plays a significant roleZhang warns that until there is a suitable increase in the long end of the government bond yield curve, the financing market should not experience substantial loosening.
Zhang further argues that in the forthcoming period, financing rates are expected to exhibit flexibilityWhen bond yields experience excessive declines, the financing environment may tighten to counteract this trendConversely, if bond yields rise rapidly, the financing environment may be relaxed accordinglyThis flexible mechanism of regulating financing rates contributes to the stability of financial markets and encourages healthy development within the real economyThrough precise management of the funding environment, the central bank aims to guide reasonable fluctuations in market interest rates, ultimately creating an appropriate monetary and financial backdrop conducive to economic growth.
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