China's interest rate reform advances, challenges ahead

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China's interest rate reform advances, challenges ahead

(Xinhua) 18:02, August 23, 2013

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China's interest rate reforms entered a new stage as central bank governor Zhou Xiaochuan said that the country is ready to free deposit interest rates.

Zhou said during an interview on Monday that reform is under way as planned, without specifying any schedule. He is personally optimistic, which was seen as an official signal to continue the reform after last month's first step.

The People's Bank of China (PBOC) announced a key move on July 19 to liberalize bank lending rates. The floor limit for lending interest rates will be canceled and financial institutions can decide their own rates following commercial principles, according to a PBOC statement.

Controls on bill discount rates will be scrapped and the ceiling limit for lending from rural banks will be eliminated. Lending rates for personal homes will be retained to ensure healthy growth of the property market.

Lu Zhengwei, chief economist with Industrial Bank, said canceling the floor for lending rates is a remarkable step in the reform, and the pricing of deposit rates shall now be under the control of financial institutions.

Reform of state-owned enterprises needs to be deepened to build a fairer environment for private businesses to benefit from lower lending rates, Lu added.

Ba Shusong, a researcher from the Development Research Center of the State Council, said the interest rate reform will have a long-term effect on the commercial banking system, and differentiate specific service targets for large and small banks.

The reform will cut costs for business financing, provided that the threshold becomes lower and government realizes better controls of potential risks, Ba added.

Deposit insurance programs are crucial to cushioning the shock of reform in the banking system, considering issues that arose during similar reforms in the U.S. and other Asian countries.

In June, the PBOC said the long-awaited deposit insurance system is ready to be launched to increase flexibility of commercial banks in terms of financial innovation and risk control.

Deposit insurance programs protect bank depositors by guaranteeing that a certain level of deposits will be repaid, even if a commercial bank goes bankrupt and cannot pay them.

The Chinese government is determined to regenerate its outdated economic system, with marketization of interest rates high on the reform agenda. In June and July of 2012, the central bank widened the floating bands for lending and deposit rates.

In the second quarter of 2013, the Chinese economy grew 7.5 percent year on year, slowing from 7.7 percent in the first quarter, as the government deliberately cooled down the growth in exchange for space for rebalancing the economy,allowing a more sustainable expansion.