China’s ten-year government bond market has been booming, causing strong anxiety among Chinese policy makers as they fear a crisis similar to the 2023 Silicon Valley Bank collapse.
Similar to Silicon Valley Bank, small and medium financial institutions in China have invested heavily in long-term government bonds, making them vulnerable to sudden interest rate changes.
The People’s Bank of China started borrowing bonds and then selling them on Monday (July 1) to lower bond prices, attempting to increase bond yields. This unprecedented move indicates Beijing’s growing concerns.
On Monday, the onshore 10-year government bond yield dropped to 2.18%, the lowest level since the data began recording in 2002. The 20-year and 30-year government bond yields have also been hovering at historical lows.
Zhang Jiqiang, Chief Fixed Income Analyst at Huatai Securities, told CNN that Monday’s actions suggest the People’s Bank of China “hopes to avoid a Silicon Valley Bank-style crisis.”
In China, due to the sluggish real estate market and unreliable stock market investments, most funds are concentrated in the government bond market. Rural financial institutions are the main players in bond purchases, and compared to state-owned large banks, they have weaker customer bases and capabilities.
Additionally, as the demand for corporate funds stagnates and quality loan targets are hard to find, these banks have no choice but to focus their funds on the government bond market.
Since April, the People’s Bank of China has issued more than ten warnings that the bond bubble could burst, leading to financial market instability and disrupting China’s uneven economic recovery.
At the end of June, People’s Bank of China Governor Pan Gongsheng said at a financial forum in Shanghai, “Currently, we must closely monitor the duration mismatch and interest rate risks brought about by non-bank entities holding large amounts of medium-to-long-term bonds,” including Chinese insurance companies, investment funds, and other financial firms.
Silicon Valley Bank was the largest bank bankruptcy case in the United States since the global financial crisis. The bank’s collapse stemmed from investing billions of dollars in U.S. government bonds, which they thought was a safe investment. However, when the Federal Reserve began raising interest rates to curb inflation, the bond prices held by Silicon Valley Bank plummeted, eroding the bank’s finances.
The People’s Bank of China has long been concerned about speculative government bond investments and believes that if the government bond frenzy is not contained, China’s economy could face a crisis similar to that of Silicon Valley Bank.
CNN reported that Beijing is worried that if the government bond bubble bursts, causing bond prices to fall and yields to rise, these lenders could suffer huge losses.
Magazine Chief China Economist Hu Weijun said, “Due to the real estate crisis, credit demand is weak. Therefore, banks have to buy more bonds because funds are trapped in the interbank market.”
He added that investors are also predicting a “deflationary outlook” for the Chinese economy, prompting them to buy long-term sovereign bonds in droves.
According to an analysis by state-owned securities firm Zheshang Securities of central bank data, in the first half of this year, financial institutions (mainly local banks) net purchased sovereign bonds amounting to 1.55 trillion yuan, a 61% increase from the same period last year.
Hu Weijun estimated that around “4,000 small and medium-sized banks” in China are particularly vulnerable to interest rate risks. Once interest rates begin to rise, these banks will incur huge losses and bear the risks.
In an editorial, the Securities Times stated, “The bubble formed by the inflow of funds into the bond market is accumulating interest rate risks.”