A research note from Jefferies analysts Krishna Guha and Joseph Dickerson titled “RMB/CNH Funding – Next Hot Spot?” of July 17, 2014 raises the possibility of demand for loans shifting out of the US Dollar into RMB, given that the appreciation in the RMB may have paused.

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But this new demand could face a liquidity mismatch in Hong Kong due to the reduced inflow of CNH deposits following strength in CNH during recent months.

An HSBC report last week confirmed this, attributing this to “slowing new CNH generation as a result of a subdued currency performance, while overseas financing demand has been strong:”

“Putting the numbers into perspective, net RMB outflows from the Mainland declined to RMB27bn in May from an average RMB121bn in 1Q 2014. New RMB deposits in Taiwan fell to RMB6bn in May, down from an average RMB14bn since January 2013, while those of Hong Kong declined for the first time since July 2013. We are not overly concerned on this because the offshore liquidity will likely return once the currency strengthens, as happened in late 2012.”

RMB denominated loans

“Now that the perceived certainty of one way appreciation is a thing of past, we think it is quite likely that previous USD-denominated loan demand may shift to a RMB-denominated one,” say the analysts at Jefferies. “Amidst a backdrop of slowing offshore RMB deposit growth in HK, one needs to look at yuan liquidity in HK.”

On the face of it, there should be no problem considering RMB loans outstanding in Hong Kong amount to RMB123B while deposits stand at RMB955B – a loan-deposit ratio of a comfortable nearly 13%.

Yet, what is causing the spike in interbank rates?

The analysts are concerned that 1-week interbank rates have been moving up since April, even though the Shanghai 1-week interbank rate has remained basically unchanged.

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Temporary imbalance

The analysts think the phenomenon could be a “temporary imbalance of segmented liquidity,” and point to a seeming distortion in CNH deposit rates in explanation.

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