Expectations mount for more China interest rate liberalisation

What will be the next step in Beijing's interest rate liberalisation programme? The forecasting game has begun after the central bank freed up lending rates earlier this month, disappointing market participants who had anticipated a more significant change.

It had been widely expected that the government would allow deposit rates to float upwards by another 10 per cent, following a similar move in June last year, in the light of the new leadership's expressed desire to let market forces play a bigger role in deciding interest rates this year.

The abolition of the floor on loan rates announced by the People's Bank of China was a small step in the liberalisation of rates, because the allowed band of 30 per cent below the PBOC's benchmark rate was almost never fully exploited by banks, which benefit from a seller's market in loans to firms.

If banks were free to set their deposit rates, however, the rates could rise significantly as smaller lenders would compete for deposits. As a result, banks would no longer be able to enjoy such fat profits from simply taking deposits and making loans.

"The scrapping of a ceiling on deposit rates would be the final step in China's interest rate liberalisation," Wu Xiaoling, a former PBOC vice-governor, said at a Beijing forum on Tuesday. "It is unlikely to happen either this year or the next."

Wu said a sudden lifting of the deposit rate ceiling would likely result in rate wars among financial institutions, threatening the survival of small lenders. She said the launch of a deposit insurance system to protect depositors would be a prerequisite for abandoning the deposit rate ceiling.

S&P analyst Liao Qiang said the liberalisation of deposit rates was set to be gradual, as policymakers struck "a delicate balance" between pushing ahead with the financial reform and maintaining banks' profitability that would allow them to absorb losses from bad loans.