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Hong Kong’s central bank will start providing Chinese currency loans to the city’s banks on Friday to prevent a shortage of liquidity from destabilising the offshore renminbi market.

The Hong Kong Monetary Authority announced on Thursday that it would offer one-week renminbi loans in exchange for high-quality collateral such as Chinese government bonds.

“Such a backstop facility will calm nerves as banks will be able to approach the monetary authority for more renminbi funds whenever necessary,” said HSBC in a note to clients.

Liquidity squeezes have shaken the offshore renminbi money markets on three occasions since the start of the year, with short-term interest rates spiking as lenders scrambled for funds.

Analysts said the HKMA’s new loan facility would alleviate short-term tightness in the market, which has grown rapidly over the past two years but is still small and illiquid.

The offshore renminbi market started in Hong Kong in 2010 and has since spread to London and Singapore. While there are few restrictions on renminbi trading in these offshore centres, Beijing retains extensive capital controls that cut them off from the vast pool of liquidity in mainland China.

As investors have stopped expecting the renminbi to appreciate against the dollar in recent months, the total pool of renminbi deposits in Hong Kong has contracted 12 per cent from a peak of Rmb627bn in November 2011.

At the same time, Hong Kong banks have expanded their renminbi loans, raising concerns about a lack of liquidity.

The HKMA’s facility makes use of its Rmb400bn currency swap arrangement with the People’s Bank of China.

The monetary authority said the interest rates on its renminbi loans would be determined “by reference to prevailing market interest rates”.

Weisheng He, Asia forex strategist at Citibank, said that until the HKMA specified the exact rates on the facility, it would be hard to determine how much it would impact the market.

“However, it will certainly cap the upside in liquidity squeezes and the knowledge that HKMA can provide a liquidity backstop will also reduce the risk of liquidity squeeze,” Mr He said.

The HKMA said Hong Kong government bonds and exchange fund bills and notes, which are denominated in Hong Kong dollars, would be acceptable collateral for its renminbi loans.

It added that while banks would be able to roll over the borrowings under the facility if needed, it “should not be regarded as a steady source of funding for their business”.

In another significant move on Thursday, the HKMA said Hong Kong banks would be allowed to use a wider range of renminbi assets as part of the statutory liquidity ratio. This means banks will be able to hold less renminbi cash in reserve, boosting market liquidity.

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