The People's Bank of China (PBC), the country's central bank, announced Friday that it will remove all the restrictions on lending rates for financial institutions. This means they will no longer need to abide by the floor limit of 70 percent of the PBC's benchmark lending rates and will be able to set their own rates for the loans they issue, effective July 20.
While the move has been widely welcomed as key to liberalizing the country's interest rate policies, the most important step has yet to come: freeing up banks' deposit interest rates.
Removing the caps on deposit rates is the most risky part of interest rate reform and will have a much greater impact on the financial system than canceling the controls on lending rates. This is because deposit rates represent the price banks must pay to attract capital from depositors.
In an immature market, hasty liberalization of deposit rates may lead to banks irrationally raising their deposit rates to attract savers. If these rates are too high, the banks will be unable to meet their obligations to depositors, precipitating a bank run.
China's effort in pushing forward interest rate marketization saw some relaxation in controls of deposit rates last year. On June 7, 2012, the PBC expanded the ceiling of deposit rates to 110 percent of its benchmark, a development which marked a crucial step in liberalizing deposit rates.
Sheng Songcheng, head of the PBC's statistics department, wrote in an article earlier that to liberalize deposit rates, China needs to further expand or scrap the upper limits on rates of medium- and long-term deposits before extending to short-term and small-sum deposit rates and finally dropping the curbs on deposit rates altogether.
Although there is a strict curb on deposit rates, banks are still able to attract capital through wealth management products, which are not subject to the rate restrictions. But these must compete with trust products, equity products and fund products, which also pay far higher rates of return than bank deposits. Then there are the illegal private lenders to consider. These all make it harder for banks to attract desposits. To address this problem, the country should quicken its pace in rate reform.
Meanwhile, there are several issues regulators need to pay attention to when pushing forward the reform in deposit rates.
First is the aforementioned danger that vicious competition among banks to attract savings may lead to runs on some smaller banks. Second, allowing banks to compete in terms of deposit rates will inevitably drive up loan rates, affecting the development of the real economy. Third, a deposit insurance system is urgently needed to protect the interests of savers against the risks resulting from interest rate liberalization.
Floodwater gushes from sluices of Gezhou Dam, China's Hubei
Feedback
RSS
