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China quickens pace of interest rate liberalization
By Chris Leung |
July 9, 2012, Monday
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Print Edition
Print Edition
CHINA announced on Thursday evening to cut the benchmark one-year lending rate and one-year deposit rate by 31 basis points and 25 basis points to 6 percent and 3 percent, respectively. This is the second cut within a month.
On the surface, the move aims at shoring up weakening loan demand seen lately. Many may speculate the move is probably in anticipation of weaker-than-expected second-quarter GDP due this week.
It is probable that second-quarter GDP may advance less than 8 percent. However, the People's Bank of China also states clearly that tight control on property related loans will firmly remain. And it is the property developers that need lower cost of capital the most to survive.
It is also doubtful banks will be willing to lend money to smaller firms at lower rates given the prevailing economic climate filled with risks everywhere.
The essence of the latest asymmetrical rate cuts, in my view, is again related to the whole exercise of interest rate liberalization.
After lowering the lending rate floor to 80 percent of the benchmark rates on June 7, the central bank lowered it again to 70 percent on Thursday. Banks can now offer a maximum discount of 30 percent on the benchmark lending rate. For instance, the lowest possible one-year lending rate can go as low as 4.2 percent now.
On the deposit side, the fact that the banks can offer 10 percent higher than the benchmark means the deposit rate in reality is 3.3 percent. The margin spread for the best borrowers facing the banks is thus only 90 basis points. To compare, profit spread before the cuts and relaxation on lending rate floor and deposit rate ceiling on May 12 was 240 basis points. As a result, banks are making less money than before from their best customers.
The relaxation on the lending rate floor will likely trigger more intense competition amongst banks. That will force them to rationalize their lending decisions. If they make less money from the same group of customer, they probably have to offset the margin compression by charging higher rates to riskier borrowers. This will improve the asset quality of the banks in the long run.
Cut-throat competition
The authority has to pace the liberalization exercise sensibly so as to avoid fueling cut-throat competition amongst the banks. As the last "rate cut" exercise showed in June, deposit rates went up the next day after banks were granted the freedom to offer deposit rates 10 percent higher than the benchmark.
The situation reveals Chinese banks are also fearful of losing deposits. Such experiences are very much in line with international experiences shown by other countries during the course of interest rate liberalization.
That explains why there is no corresponding relaxation on the deposit rate ceiling this round. It can't be executed too fast or else banks' margin will be gyrated too soon creating other problems.
Once again, China's recent moves on monetary policy have tremendous strategic implications. The plan is to kick off the whole liberalization exercise that was put into a halt for almost a decade.
Once it started, the authority observes the competitive behavior of the banks. Then they carefully plan for the next move. The current plan is obviously to fully liberalize lending rate first by gradually removing the floor.
Future interest rate cuts from now on will likely to be accompanied with incremental moves on rate liberalization.
And this will be very interesting because they are moving fairly fast on this front than anyone's expectation.
On the surface, the move aims at shoring up weakening loan demand seen lately. Many may speculate the move is probably in anticipation of weaker-than-expected second-quarter GDP due this week.
It is probable that second-quarter GDP may advance less than 8 percent. However, the People's Bank of China also states clearly that tight control on property related loans will firmly remain. And it is the property developers that need lower cost of capital the most to survive.
It is also doubtful banks will be willing to lend money to smaller firms at lower rates given the prevailing economic climate filled with risks everywhere.
The essence of the latest asymmetrical rate cuts, in my view, is again related to the whole exercise of interest rate liberalization.
After lowering the lending rate floor to 80 percent of the benchmark rates on June 7, the central bank lowered it again to 70 percent on Thursday. Banks can now offer a maximum discount of 30 percent on the benchmark lending rate. For instance, the lowest possible one-year lending rate can go as low as 4.2 percent now.
On the deposit side, the fact that the banks can offer 10 percent higher than the benchmark means the deposit rate in reality is 3.3 percent. The margin spread for the best borrowers facing the banks is thus only 90 basis points. To compare, profit spread before the cuts and relaxation on lending rate floor and deposit rate ceiling on May 12 was 240 basis points. As a result, banks are making less money than before from their best customers.
The relaxation on the lending rate floor will likely trigger more intense competition amongst banks. That will force them to rationalize their lending decisions. If they make less money from the same group of customer, they probably have to offset the margin compression by charging higher rates to riskier borrowers. This will improve the asset quality of the banks in the long run.
Cut-throat competition
The authority has to pace the liberalization exercise sensibly so as to avoid fueling cut-throat competition amongst the banks. As the last "rate cut" exercise showed in June, deposit rates went up the next day after banks were granted the freedom to offer deposit rates 10 percent higher than the benchmark.
The situation reveals Chinese banks are also fearful of losing deposits. Such experiences are very much in line with international experiences shown by other countries during the course of interest rate liberalization.
That explains why there is no corresponding relaxation on the deposit rate ceiling this round. It can't be executed too fast or else banks' margin will be gyrated too soon creating other problems.
Once again, China's recent moves on monetary policy have tremendous strategic implications. The plan is to kick off the whole liberalization exercise that was put into a halt for almost a decade.
Once it started, the authority observes the competitive behavior of the banks. Then they carefully plan for the next move. The current plan is obviously to fully liberalize lending rate first by gradually removing the floor.
Future interest rate cuts from now on will likely to be accompanied with incremental moves on rate liberalization.
And this will be very interesting because they are moving fairly fast on this front than anyone's expectation.
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