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SHANGHAI, May 28 (Reuters) - China's central bank has drained money from cash-flush financial institutions by selling them bond repurchase agreements behind closed doors, sources with direct knowledge said, signaling policymakers' discomfort with excess liquidity in the financial system.
It is an unusual step, and was partly responsible for Chinese stocks tumbling over 6 percent on Thursday in their worst daily decline in four months.
The central bank sold 7-day, 14-day, and 28-day forward repos to financial institutions in recent days at current market interest rates, the sources told Reuters, but did not provide the amounts or name the specific banks.
Forward bond repos involve an exchange in which financial institutions use their cash on hand to buy short term repurchase, or "repo", contracts from the central bank that give a fixed rate of return; reverse repos do the opposite.
The People's Bank of China (PBOC) did not answer calls seeking comment.
"The market really has too much money," said a trader at an Asian bank in Shanghai, adding that commercial banks are now offering cash at rates below 1 percent for overnight contracts .
Chinese stock markets dropped sharply, reacting to signs of tightening up on margin financing by brokerages and the liquidity-drain. The CSI300 index of the largest listed companies in Shanghai and Shenzhen fell 6.7 percent, while the Shanghai Composite Index lost 6.5 percent.
Beijing has been steadily easing monetary policy, both lowering guidance rates and directly freeing up cash through reductions to bank reserve requirements to spur a faltering economy. The impact of these steps has shown up in the short-term money market, where the benchmark seven-day repo rate has slid below 2 percent.
However, economists are concerned that much of the fresh liquidity flowing into the market through reserve cuts has gone into feeding a blistering stock market rally, instead of easing debt costs or spurring fresh productive investment.
Fitch ratings recently estimated that the cost of servicing China's current debt is equivalent to 15 percent of GDP, more than double the current economic growth rate.
Because repo issues act as net drains or injections into the country's money supply, ordinarily the PBOC has issued both classes of contract during bi-weekly open market operations, in which it trades repos as a means of managing money rates and wider market expectations.
However, the PBOC has backed off from open market operations in 2015, instead relying on more direct but far more opaque methods of money management in which it deals with banks on a one-on-one basis. (Reporting by the Shanghai Newsroom, Lu Jianxin and Pete Sweeney; Editing by Jacqueline Wong & Shri Navaratnam)