PBOC Starts Bank Stress Tests to Avoid Stampede Out of Bonds

(Bloomberg) — China has initiated stress tests with financial institutions on their bond investments, to make sure they can handle any market volatility should a record-breaking rally reverse, according to state-run media.

Most Read from Bloomberg

The People’s Bank of China has made a gradual start to the tests recently, wary that a bull run might lead to one-sided bets in long-term government bonds, according to a front-page report by Financial News. Its intention may not necessarily be to significantly push yields higher, the central bank-backed newspaper said citing an unidentified source.

Financial institutions should be able to cope with large drops in bond prices, as crowded holdings in debt positions could easily turn into a “stampede” in the event of a sharp yield reversal, Financial News said. That can raise the likelihood of a liquidity crisis and threaten financial stability, it added.

A stellar rally in Chinese bonds has stalled amid measures to cool sentiment including having state banks sell some bonds and gathering financial institutions for meetings. That has triggered a collapse in government bond trading as investors consider the regulatory moves.

The central bank did not seek to nor will it seek to ban legitimate investments or trading in its government bonds, but it sees risks in a buying spree of the securities, Bloomberg earlier reported, citing people familiar with the PBOC’s thinking.

By doing the tests, the authorities want to see if banks can handle drastic market swings in hypothetical and extreme conditions with their current holdings of assets, the paper said. In the case of the bond market, officials may want to see how banks can react if yields surge by 10, 20 or even 50 basis points in a sudden move, it added.

Financial risks in key areas are being resolved in an orderly manner, PBOC Governor Pan Gongsheng said in an interview with state broadcaster China Central Television that aired Saturday. China will adhere to a supportive monetary policy stance and promote credit growth and gradual decline funding costs, he added.

(Update with more details in the report)

Most Read from Bloomberg Businessweek

©2024 Bloomberg L.P.