Is Full Interest Rate Liberalisation in China Now Imminent?

Chinese media reports that further interest rate liberalisation is on the cards, following the launch of slew of new opening and reform measures by Beijing.

Both domestic and overseas media outlets have recently cited sources claiming that Beijing plans to launch further liberalisation of Chinese interest rates, just following the appointment of Yi Gang as head of the People’s Bank of China (PBOC).

Securities Times reported as early as 13 February that Beijing could would loosen the ceiling on commercial bank deposit rates as currently mandated by industry self-disciplinary mechanisms, while Reuters cited sources last week stating that a lifting of the ceiling was imminent.

Chinese media has also reported that a meeting of the members of the Market Interest Rate Pricing Self-disciplinary Mechanism Organisation (市场利率定价自律机制机构) was convened on 12 April, to discuss arrangements for the loosening the ceiling on commercial bank deposit rates.

Prior to the most recent reports PBOC governor Yi Gang flagged interest rate liberalisation measures at the Boao Forum for Asia, where he said that “China is continuing to drive interest rate marketisation reforms.”

According to Yi China currently implements a “two track” interest rate system, with deposit rates still based upon a benchmark rate, and money market rates now fully determined by market forces.

“The best strategy for us is in fact to have these two interest rate tracks gradually unify – this is the market reform we want to achieve.”

China first began to liberalise interest rates in 2013, starting with the launch of interbank certificates of deposit (同业存单), followed by the cancellation of the lower threshold on lending rates in July 2013.

In 2015, amidst a string of successive rates reductions by PBOC, Beijing also lifted the ceiling on deposit rates from 1.2 to 1.5, before removing the official ceiling completely.

Yi Gang said that China has already removed controls on deposit rates, with commercial banks permitted to make upwards or downward adjustments relative to the benchmark based on their circumstances.

Observers point out, however that only lending rates are now fully market-based, with deposit rates still subject to heavy de facto controls.

These controls include the formal pricing guidance of PBOC, as well as the “hidden” restraints of the industry’s self-disciplinary mechanism, with deposit rates not permitted to move upwards in excess of 50%.

These controls have been to the immense benefit of lenders, shoring up their profitability and freeing them from the need to compete for funds with higher returns.

At present the benchmark rate for a 1-year deposit is just 1.5%, with Chinese banks permitted to implement a hike of 50%,, for a maximum rate of 2.25%.

The benchmark rate for a 1-year loan is 4.75%, with the average premium against the benchmark standing at 26%, meaning that some bank loan rates are approaching 6%, for a net interest spread of around 4 percentage points.

“Happiness is the product of struggle, yet there are still two industries in China that do not earn money via struggle, but simply by lying on their backs,” said Jiang Chao (姜超) of Haitong Securities to Hexun. “One of them is banking, and the other is real estate.

While rates for wealth management products and certificates of deposit are fully liberalised, nearly 70 trillion yuan of the roughly 252 trillion yuan of liabilities in the Chinese commercial banking system are comprised of deposits, which means that a third of such liabilities are still subject to rate controls.

Market researcher Wang Jian (王剑) said to Hexun that under ideal conditions the central bank’s open market operations, via repos, medium-term lending facilities and short-term lending facilities, would impact money market rates such as SHIBOR, before subsequently impacting deposit rates.

PBOC would be able to influence deposit rates because commercial banks are capable of tapping funds from both the deposit market and money market, expediting an alignment in the costs of both in order to avoid opportunities for arbitrage.

According to Wang the full liberalisation of deposit rates would greatly abet the Chinese central bank’s ability to transmit its policy-decisions.

The most opportune time for the implementation of full liberalisation of interest rates will arrive when the disparity between the informally controlled deposit rate and money market rates are at their lowest, which given the low levels of the former would likely arrive during a period of loose monetary policy.

Zhang Xu (张旭), fixed-income analyst for Everbright Securities, expects policymakers to gradually reduce their covert control of deposit rates by slowly raising the upper threshold.

Observers expect the interest rate liberalisation to have a profound impact upon both the banking sector and the broader Chinese economy.

Jiang Chao points out that the net interest spread of 4 percentage points has enabled China’s bank-dominated financial sector to usurp a disproportionate share of the country’s economic growth, with the total profits of 25 listed lenders reaching 1.3 trillion yuan in 2016, or as much as 46% of the profits of all listed concerns.

Strict controls on interest rates have also helped to inflate the real estate bubble, given that the real negative returns provided by bank deposits incentivise the purchase of other assets.

“China’s stubbornly high housing prices are very closely related to the fact that the marketisation of interest rates has not been fully implemented,” said Jiang.

Jiang further points out a rise in deposit rates could serve to increase household incomes and be of benefit to long-term consumption gains, while conversely a reduction in lending rates will reduce the financing burden for enterprises.

For these reasons Jiang expects interest rate liberalisation to help China to achieve its long-term objective of ensuring that “finance serves the real economy.”

Other observers are far less sanguine, with CITIC Securities expressing concern that given the launch of new asset management and wealth management products (WMP) regulations, the returns on savings for households could still see an overall decline.

CITIC Securities anticipates trouble for the economy should households instead choose to channel more of their money into the real estate market or overseas.

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