Finance

Duncan Mavin is a former Bloomberg Gadfly columnist.

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

There are plenty of bankers who'd have you believe that trading in China's currency is the next big thing. So the implications of getting shut out of part of the market should be a big worry too.

Standard Chartered, Deutsche Bank and Singapore's DBS will be contemplating that issue right about now, according to news reports that they're among a small group suspended by Chinese authorities from some trading of the onshore version of the yuan.

Declining Fortunes
Bloomberg

The ban comes as the People's Bank of China tries to manage its currency downward. On Thursday, China's central bank set the daily yuan fixing 0.51 percent lower, the biggest drop since it surprised markets by devaluing the currency in August.

The direct and immediate financial impact will probably be modest, even if it's not easy to tell exactly how the ban affects the bottom line of any of the banks. Yuan trading is on the rise, and obviously plays a larger role in the Asian regional operations of global banks. But it's still a fraction of the global foreign exchange market. Trading in the onshore version of China's currency is limited mostly to Chinese domestic institutions with whom Western banks do only limited business.

What should be of far greater concern to the banks is what the move signals: the increasing alarm in Beijing about the widening spread between the onshore yuan and the offshore version of the Chinese currency. This is the real motivation for the ban by the PBOC, which is eager to quell a source of potential volatility and speculation.

Mind The Gap
The spread between the onshore and offshore yuan has widened sharply
Bloomberg

The spread has picked up sharply in 2016. That's not good for the PBOC (and, in truth, it's not good for the banks either). As Bernstein analyst Chirantan Barua notes, the last time the spread widened significantly in 2014, Standard Chartered's financial markets income fell 21 percent in the first half of the year as clients reduced their demand for hedging in the expectation the country's central bank would act to close the gap.

So while western banks might benefit from the arbitrage trade on the widening onshore/offshore spread, the far bigger impact is that clients and banks are scared to get involved in yuan trading. Barua calculates that, with foreign exchange revenues up to 10 percent of Standard Chartered's total income, the impact on the bank's bottom line could be as much as 5 percent. (Barua notes that HSBC has a similar problem given its large yuan exposure).

In other words, the banks should really be grateful that the PBOC has imposed a ban on their onshore yuan trading if that's a sign the central bank is also trying to tighten the offshore/onshore spread.

The only problem is that where Beijing gives with the one hand, it has the potential to take away with the other. A recent survey of companies inside and outside China by Standard Chartered found that a third of those outside the country said they responded to the August devaluation by actively reducing their renminbi position.

So while a short-term ban from trading the nascent market probably won't do too much damage to the profits of western banks, a lingering concern is Beijing's readiness to intervene in the markets. Too much of that and "the next big thing" quickly becomes yesterday's news.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Duncan Mavin in London at dmavin@bloomberg.net
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net