21 July 2018

China Gives Lenders More Freedom On Rates

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China’s central bank has changed its stance on interest rates and will allow lenders more freedom on setting rates in a move that may spark big changes to the country’s banking sector.

Previously, the central bank set a lower limit for interest rates on loans giving banks little autonomy in decision-making about rates. The lower limit was set at 70 percent of the benchmark rate set by the central bank. By removing the floor, borrowing costs should drop over time. But for now, few banks are expected to make loans below the benchmark rate.  

The move is seen as a sign that Beijing is trying to reform its financial system even at the cost of economic growth.  Many feel that by providing more competitive interest rates, China should see a more efficient banking sector along with the benefits of a more open economy. Rate liberalization is the first step in this process and will likely bring more investment to the area.

A second step toward interest rate liberalization, experts said, would be a loosening or elimination of artificial deposit rate ceilings. Deposit rates have been set so low that for several years Chinese savers have been earning negative interest when adjusted for inflation.

Many economists think the elimination of deposit rate ceilings would encourage smaller banks to raise interest rates in an effort to attract more customers. No indication has been given by the central bank that deposit ceilings will be eliminated any time soon.

According to Credit Suisse economists, rate competition "would increase the yield of deposit rates and shrink the margins of large banks." This could have a significant impact on “wealth management products and the corporate bond market."

Removing the deposit cap would also help to slow down the “shadow banking” system that has lured investors seeking higher yields than offered by the major commercial banks. Shadow banks have flourished by offering loans to small- and mid-sized businesses that are packaged and sold to investors looking for high returns. By allowing banks to set their own rates, the hope is that these small- and mid-size business loans would no longer be ignored and the business owners could get competitive loans.
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