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June 15, 2012

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Home » Business » Economy

Rate cuts provide spur for financial reforms

By Feng Jianmin | June 15, 2012, Friday | Print Edition

IT was an unusual interest rate cut - one that sent a wave of relief among both savers and borrowers.

Borrowers, of course, usually benefit from rate cuts. Mortgage payers will have their monthly payments reduced by about 150 yuan (US$23.7) for a 20-year, 1-million yuan loan.But in a first for China, most depositors were given a reprieve from the usual mandatory drop in interest on their fixed-term, one-year deposits.

All this is possible because the People's Bank of China has broken with tradition by allowing lenders to set deposit rates at up to 10 percent above the official benchmark rate.

The more flexible approach to rate-setting came last Thursday, when the central bank pared benchmark interest rates by 0.25 percentage point, lowering the one-year deposit rate to an official 3.25 percent and the one-year lending rate to 6.31 percent.

Depositors who have watched the value of their savings erode as inflation exceeded rates will no doubt be comforted by the news. Many people have complained about banks making big profits while their nest eggs shrank.

Everyone seems to be happy, except for the banks. They make money by taking deposits at low rates and lending it out at high rates. By allowing that margin to narrow, the central bank may be squeezing profits.

Market-driven forces

Analysts generally applauded the policy shift as a small step for the central bank but a big one for China. They noted, however, that China still has a long way to go in reforming its banking system to allow more market-driven forces to prevail.

On the second day after the interest-rate cut, China's five largest state-owned banks, namely Industrial and Commercial Bank of China, Agricultural Bank of China, China Construction Bank, Bank of China, and Bank of Communications, and some smaller regional city lenders announced they would be offering deposit rates above the benchmark.

National joint stock lenders, such as China Everbright Bank and China Industrial Bank, quickly followed suit.

Large foreign banks operating on the mainland, including HSBC and Citigroup, have generally set their one-year deposit rates at 3.5 percent, while some city lenders and smaller foreign banks, such as DBS, have raised their rate to the ceiling of 3.575 percent.

"Larger banks do not need to raise deposit rates as much as smaller deposit-taking institutions, which are generally perceived as less safe," Ma Jun, a chief economist at Deustche Bank, said in a report. "As a result, larger banks may gain market share from smaller banks or outperform smaller banks due to less contraction in interest rate margins."

Shen Wei, an analyst with Everbright Securities, said that the narrowing interest rate margin may drag down the overall growth rate of banks by 6 percentage points this year, forcing some into riskier lending for higher returns.

Small businesses

"Accelerating interest rate reform will diversify the banking sector," he said. "Banks will increase lending to small businesses, and those with strong risk management are more likely to thrive amid the competition."

Depositors also may soon be offered more choice in "wealth management" products from smaller banks as financial institutions pursue new ways of attracting deposits, he added.

Are all these positive signs for long-term financial reforms? Analysts seem to think so.

"We believe interest rate liberalization will provide the basis for more efficient financial resource allocation and form an important condition for China's capital-account liberalization," Ma said. "These fundamental reforms will eventually improve the performance of the economy."

Tom Byrne, senior vice president of Moody's Investors Service, echoed those sentiments, saying that the credit-positive measure is an important first step in much-needed reforms, even though the broad structure of interest rates remains under the administrative control of the central bank. Byrne said the move would help stabilize the amount of deposits in the banking system and would help household incomes.

China still needs to reduce preferential policies favoring loans to state-owned enterprises, diversify the business model of banks and develop a mechanism to protect deposits.

But a shift is under way.

The government is starting to offer incentives for banks to lend to small businesses. Last year, only an estimated 10 percent of privately owned companies were able to secure bank loans.

"The economy needs price signals, rather than administrative and political decisions, to ensure a more market-based and efficient allocation of capital," Byrne said. "Without that, China's growth rate trend will likely slow more rapidly than otherwise."

Han Fulin, a senior researcher at Central University of Financial and Economics, said that China should establish a system of deposit insurance to match the more liberalized interest rates.

"We've just started; freedom of pricing is still limited for banks," he said. "In the future, higher risks will come with more fierce competition, especially among small banks. Deposit insurance would increase banks' operational costs but would also enhance the confidence of depositors."

At the same time, regulators will have to sharpen their oversight to ensure that large banks given more say over rates don't engage in price manipulation or other corrupt practices.

Economy


 

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