China’s policy banks: Going where no bank has gone before?

China may soon come out with an investment vehicle the likes of which the world has never seen.

The People’s Bank of China (PBOC) is considering “lending to policy banks through a new monetary tool, so they can buy bonds issued by local governments,” according to financial news magazine Caixin Online.

The source, a person close to the central bank, was a bit sketchy on the details. All the source seemed to know for sure was that it would have a maturity of at least 10 years. Details on what it was or how it would work weren’t given.

“It will be a new monetary tool the world has never seen,” the person told Caixin. “The format does not matter, and all possible means could be taken.”

If that doesn’t get you excited, the Asia Unhedged doesn’t know what does.

The story behind the story is that local Chinese governments have a lot of debt. About 18 trillion yuan as of June 30, 2013, based on the most recent national government debt audit. Essentially, they need a bond bailout, but the PBOC doesn’t want to service it. Last month, the Ministry of Finance unveiled a plan to help the local governments extend the maturities and lower the debt-service costs of one trillion yuan through a bond swap.

The problem is the commercial banks that were supposed to buy the new bonds said if the central bank didn’t want the debt, it was obviously damaged goods and they didn’t want any either. The other problem: the new interest rates were too low, too.

Last week, the PBOC said it planned to launch its own version of the credit-easing programs seen in the U.S. and Europe to help the local governments.

Well, Wednesday’s report seems to be a testing of the waters on what the market will tolerate. The gist of the latest idea is the central bank will create new instruments to provide the China Development Bank and perhaps other policy banks with the capital to buy the bonds the local governments will issue.

Caixin said part of the solution was to revise the Budget Law, which prohibited local governments from directly borrowing, and allow them to issue bonds.

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