Why ultra-low interest rates could imperil China's state-owned banks
And why Xi Jinping might actually be happy about it...
A leading Chinese economist says one of China’s biggest economic challenges is dealing with the inevitable onset of ultra-low interest rates, and the profound changes this could wreak upon the nation’s financial system
Li Yang(李扬), director of the National Institution for Finance & Development (NIFD) and former deputy-head of Chinese Academy of Social Sciences (CASS), says low rates could lead to disintermediation of the all-important state-owned banking sector, by triggering an exodus of funds towards China’s capital markets.
In a sharp change from precedent, however, this could be viewed as a positive development by Xi Jinping, given Beijing’s core reform goal of stepping up the role of capital markets in supercharging the development of China’s tech sector.
Ultra-low interest rates destined for China’s economy
Li said that Chinese economists have long considered ultra-low interest rates to be a problem for the rest of the world economy - one that did not have direct implications for the execution of monetary policy within China.
While the Fed cut rates to deal with the bursting of the tech bubble and the sub-prime meltdown during the first decade of the 21st century, China rode a wave of strong GDP growth in the wake of its ascension to the World Trade Organisation (WTO) in December 2001.
This left Beijing with little impetus to cut interest rates or engage in monetary or fiscal stimulus until the Global Financial Crisis (GFC) in 2008.
“From the end of last century until 2019, 2020, the world passed through a near twenty-year period of ultra low, and even negative, interest rates,” Li said in a speech delivered on 16 August 2025, at the 2025 Asset Management Annual Conference held in Shanghai’s Pudong financial district (“李扬：当前中国经济运行的若干问题.”)
“Our teams engaged in deep research of this issue, but research at the time gave the strong sense that we were watching fires blaze from afar.
“No one imagined that low interest rates, or even ultra-low interest rates, would one day descend upon China.”
The situation has changed in the post-Covid era, with Li pointing to pressure on interest rates as one of the most critical issues for the Chinese economy at present.
“Right now, the biggest challenge is interest rates - further declines in interest rates are a highly probable trend,” he said.
“Following analysis of trends in key indices including bond yields, the Shanghai Interbank Offered Rate (SHIBOR) and the loan prime rate (LPR), we can see that various interest rates have all displayed a pattern of decline.
“This will continue to be the trend in future.”
China’s state-owned banks threatened by low rates
China’s financial system has long been characterised by the dominance of the banking system relative to debt and equity markets, as well as the dominance of the banking system by state-owned lenders under the sway of Beijing.
In practice, this means China’s financial policymakers are well-positioned to exercise tremendous control over the allocation of credit - and thus resources - within the national economy.
They can achieve this via their multi-faceted influence over the state-owned banks - in the form of window guidance, structured monetary policy, or even direct administrative orders to either step up or reduce lending to different sectors of the economy.
Observers have long argued that low interest rates are problems for the Chinese banking system - and thus the broader economy, because they squeeze their profitability by reducing the interest revenues they earn on loans.
While the banks can offset the issue by reducing their deposit rates, this creates the problem of reducing the returns on the savings of Chinese households.
This in turn creates the two problems of weak domestic consumption and speculation-driven asset bubbles in the stock and property markets.
Chinese households lose out on wealth from the financial system - which makes them less inclined to engage in discretionary spending - while they also become more inclined to use speculative investment to chase more lucrative yields that might be available elsewhere.
Disintermediation of Chinese banks a new issue
Li argues that ultra-low interest rates create another challenge for the Chinese economy - they could weaken the state-owned banking system by driving a wave of disintermediation, as savers withdraw their low-return deposits to plunk them in other parts of the financial system.
“Low interest rates have been accompanied by a critical phenomenon which is extremely rare in China,” Li said.
“This is funds flowing away from the balance sheets of banking-sector financial institutions, towards non-bank financial institutions or the financial market itself - what’s known as ‘disintermediation.’”
The latest data from the Chinese central bank indicates that in the first seven months of 2025, China’s aggregate social financing (a broad measure of credit extension in the Chinese economy) increased by more than 5.12 trillion yuan compared to the same period last year.
However, the rate of growth in bank loans (including renminbi and foreign currency loans to the real economy, entrusted loans and trust loans) all declined to varying degrees.
Beijing could embrace bank disintermediation if it boosts China’s stock market
Disintermediation and the contraction of state-owned bank balance sheets may well have caused alarm, if not panic, amongst Beijing’s economic helmsmen in preceding years.
As recently as the first quarter of this year, the spectre of disintermediation of state-owned lenders raised hackles amongst China’s economic commentariat.
Observers expressed concern that low interest rates were eroding the deposit bases of banks, by prompting Chinese households to withdraw their deposits and place them instead with wealth management products (WMPs).
WMPs tend to invest in the bond market, where prices are wont to rise in response to low interest rates.
Li argues that Beijing may now view disintermediation as a positive development, given Xi Jinping’s push to increase the role of capital markets in financing China’s economic development - in particular the scientific and technological innovations it needs to decouple from the US tech sector.
Xi wants to increase the role of stocks and bonds in allocating funds towards productive undertakings by means of market-based mechanisms, as opposed to the state-owned banks that are subject to the direct administrative controls of the government.
Beijing also wants a rising stock market to create wealth effects that make Chinese households more inclined to spend on consumption, creating demand that compensates for the hit that exports will take as a result of Trump’s Liberation Day tariff war.
For this reason, Li argues that the current focus of China’s financial reforms is “the conversion of household savings into enterprise capital,” and that “capital markets are at the core of achieving this transformation.”
While some Chinese observers have viewed the latest raft of aggregate social financing data pointing to declining loan growth rates as a cause for alarm, Li sees the matter differently.
He said it “clearly indicates that China’s aggregate social financing is undergoing structural change that bodes well for the positive transformation of capital markets, including asset management markets.”
“As interest rates decline, net profit margins are squeezed and disintermediation appears,” Li said.
“This will create an extremely rare environment for the development of capital markets in China.”
This is a very confused assessment. Commercial banks hold deposits from households and pay an interest. These are liabilities on the bank’s balance sheet. The interest rate paid out here is unrelated to the interest charged on loans made by the bank. These loans are made ex nihilo; they are *not* contingent on retail deposits. Interest charged on loans is a function of bank determination taking into account factors such as perceived risk, profit targets, competition etc.
Deposits are a liability that the bank must honour, but the bank can always manage its liquidity through central bank reserves, interbank markets, or other funding, so the cost of deposits is not a strict constraint on lending rates.
Central bank policy rates can shape the interest rate window for banks as they need to manage reserve liquidity. Central bank rates affect the cost of banks accessing liquidity.
As for depositors, some may well draw down bank deposits and shift to more volatile assets such as securities. But this is not akin to changing the broad structure of enterprise financing, which remains dominated by bank lending.
This is a very confused assessment. Commercial banks hold deposits from households and pay an interest. These are liabilities on their balance sheet bank’s balance sheet. The interest rate paid out here is unrelated to the interest charged on loans made by the bank. These loans are made ex nihilo; they are *not* contingent on retail deposits. Interest charged on loans is a function of bank determination taking into account factors such as perceived risk, profit targets, competition etc.
Deposits are a liability that the bank must honour, but the bank can always manage its liquidity through central bank reserves, interbank markets, or other funding, so the cost of deposits is not a strict constraint on lending rates.
Central bank policy rates can shape the interest rate window for banks as they need to manage reserve liquidity. Central bank rates affect the cost of banks accessing liquidity.
As for depositors, some may well draw down bank deposits and shift to more volatile assets such as securities. But this is not akin to changing the broad structure of enterprise financing, which remains dominated by bank lending.