SHANGHAI China's central bank moved on Tuesday to further assure markets it would provide cash to institutions that need it following days of turmoil that pushed shares to their lowest level in more than four years on fears of a banking crisis.
It said it had given cash to some institutions facing temporary shortages and would continue to do so if needed.
The People's Bank of China (PBOC) wants to curtail funds that are flowing into the country's vast informal loans market and push money instead into more productive areas of the economy as it seeks to shore up growth.
But its tough stance of allowing cash conditions to tighten, which drove short-term interest rates to extraordinary levels on some deals, had raised fears of a lasting credit crunch and roiled markets globally.
In a statement late in the day that reaffirmed its drive to get banks to control their lending, the PBOC said it would provide cash to institutions that support the real economy.
"The central bank will provide liquidity support to financial institutions that face temporary shortages, but which have been lending, at prudent amounts and pace, in line with government policy and supporting the real economy," it said.
"The central bank will also take necessary measures to help those institutions who have problems in managing liquidity to maintain overall stability in the money market."
Earlier in the day Chinese shares touched their lowest level since 2009, adding to days of falls on concerns over the face-off between the central bank and the market.
But they recovered a lot of lost ground late in the day in anticipation of a central bank media briefing after the end of trade.
"The liquidity risk in the banking system is under control," Ling Tao, vice-governor of the Shanghai branch of the PBOC, told the briefing. "We will stabilise market expectations and guide market interest rates to reasonable levels."
The CSI300 index of leading Shanghai and Shenzhen listings ended down just 0.3 percent, having fallen close to 7 percent earlier to its lowest since January 2009. It fell 6.3 percent on Monday.
Reports of outages at cash machines at some banks added to market nervousness, with the index of financial stocks on the Shanghai exchange falling 7 percent at one point before recovering to close down a mere 0.1 percent.
It was not immediately clear if the PBOC statement would be enough to calm markets on Wednesday, but money traders welcomed the more accommodating tone.
"The PBOC appears to soften its position slightly," a money trader at a Chinese commercial bank in Shanghai said. "It appears the peak of the market squeeze is over."
Money market rates soared last week after authorities allowed cash market conditions to tighten. Although short-term rates have fallen this week, bank stocks have tumbled on concerns tight funding would hurt earnings and the economy.
Overnight and 7-day rates eased again on Tuesday after the central bank did not drain funds from money markets, but weighted-average rates of over 5.8 percent and 7.4 percent respectively were still well above long-run levels.
Underscoring the tight conditions, there were spikes to 15 percent and higher for some deals during the day.
RISK WORTH TAKING
Investors also fear that funding for many companies may dry up if credit conditions stay tight, forcing the world's second-largest economy to slow more than expected.
Several economists, however, praised the authorities, saying it was a risk worth taking to steer the economy away from debt-fuelled investment in infrastructure and property to a more sustainable path.
"The liquidity squeeze is the first real economic test for China's new leaders, to prove their willingness to overcome tough economic issues not with words, but by their actions," Zhiwei Zhang, a China economist for Nomura in Hong Kong, said in a research note.
"If the new leaders maintain their current approach, we believe it will add downside risk to growth in 2013, but in our opinion this would help reduce systemic financial risks, supporting long-term sustainable growth."
For decades China's rapid ascent has been powered by heavy investment fuelled by cheap, readily available credit, including massive spending in 2008 and 2009 that was said to have helped the global economy avoid a severe depression.
But with most analysts estimating China's total non-financial debt at around 200 percent of economic output and increasing amounts of it being funneled to the shadow system of wealth management products and trust funds, the new leadership of President Xi Jinping has been trying to cool down lending.
The market turbulence of the past week and violent and nervous investor reaction, however, highlighted the risks of Beijing's new approach to its debt headache.
"We believe the biggest risk comes from the PBOC potentially mishandling the situation," Bank of America Merrill Lynch analysts said in a note.
"In our view, dealing with banks in breach of regulations should be done by improving prudential regulations rather than engineering an interbank credit crunch which could potentially backfire should banks lose mutual trust."
(Additional reporting by Lu Jianxin, David Lin, Langi Chiang, Xiaoyi Shao, Aileen Wang and Shanghai Newsroom; Writing by Tomasz Janowski; Editing by John Mair and Clarence Fernandez)
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