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China’s road to free up interest rates on last mile
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AFTER a series of reforms, China’s decades-long endeavor to free up the interest rates is finally reaching the last mile.
On Tuesday, the People’s Bank of China issued a regulation for financial institutions to issue large-denomination certificates of deposit, known as CDs, to individuals and companies, which analysts hail as a key step forward to fully liberalize interest rates.
The CDs are tradable deposit agreements that allow lenders to bypass the interest rate controls. Currently, China has removed its grip on lending rates, but the ceiling on deposit rates is still retained at 1.5 times the benchmark.
“The introduction of the CDs is a milestone in pushing China’s interest rate reform through the last mile,” said Deng Haiqing, an analyst with CITIC Securities.
The participation threshold for purchasing a CD is set at 300,000 yuan (US$48,400) for individual investors and 10 million yuan for institutions, according to the PBOC.
Interest on the CDs will be mainly determined by the market. Banks and investors can set a fixed or a floating rate, using the Shanghai Interbank Offered Rate (Shibor) as a benchmark.
Shibor, which measures costs of interbank borrowing that is not under state control, stood at 3.191 percent for six-month loans and 3.4080 percent for one-year loans yesterday.
The current interest rates for six-month and one-year ordinary deposits cannot exceed 3.075 percent and 3.375 percent, respectively.
With higher returns and less risks due to the deposit insurance system already in place, the CD scheme is set to offer banks new channels to lure deposits at a time when they are under attack from other wealth-management products and a booming stock market.
Central bank data showed outstanding yuan deposits stood at 125.76 trillion yuan as of the end of April, up 9.7 percent year on year. The growth slowed 4.6 percentage points from a year earlier.
More investment options
Lou Lili, general manager of the strategy and innovation department under Evergrowing Bank, a Chinese joint-stock commercial bank, said the CDs tailored to investors will further enrich investment options in China’s financial market.
“Meanwhile, the certificates’ tradable feature will help enhance deposit liquidity,” Lou said.
But at the same time, the freedom to price the rates is likely to set off fierce competition among the lenders, which may translate into higher financing costs for the struggling real economy, a report by Huatai Securities warned.
In the long term, however, liquidity flow will become more market-oriented once interest rate liberalization is achieved, the report added.
Interest rate liberalization is a significant part of China’s pledge to allow the market to play a decisive role in allocating resources.
Freer interest rate
Zong Liang, a finance researcher at the Bank of China, said Tuesday’s introduction of CDs would enhance banks’ capability to independently decide the price of interest rates, and nurture social expectations of market-based rates.
Since 1996 when the country removed its control over interbank lending rates, China has taken incremental steps toward interest rate liberalization, including a move in July 2013 to scrap the floor limit for bank lending rates and, later, a guideline for piloting negotiable deposit certificates on the interbank market.
On May 1, the long-awaited deposit insurance scheme was put in place, which was considered a precondition for China to free up deposit rates.
At a press conference on the sidelines of the national legislature’s annual session in March, central bank Governor Zhou Xiaochuan said the possibility for China to fully liberalize its interest rate mechanism is “very high” this year.
And with Tuesday’s introduction of the CDs, Guojin Securities predicted the grip on deposit rate will be removed by the end of 2015.
RATING the journey to liberalization
IN 1996, China removed control over interbank lending rates.
In 2004, the central bank scrapped an upper limit for banks’ lending rate and allowed a downward float of not over 10 percent from the benchmark lending rate.
In July 2013, the central bank fully scrapped the floor limit for banks’ lending interest rate.
In December 2013, the central bank gave green light to the issuance of interbank negotiable certificates of deposit, which expanded banks’ financing channels and encouraged market-based interest rates.
In May 2015, China began implementing the deposit insurance scheme, which is regarded as an important part of financial safety and a precondition for China to free up deposit rates.
On May 10, 2015, the central bank lifted the upper limit of the deposit rate’s floating band to 1.5 times the benchmark from 1.3 times, granting banks more pricing autonomy.
On June 2, 2015, the central bank let banks issue certificates of deposit to individual and institutional investors, less than two years after the issuance of certificates was rolled out among banks.
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