China rates liberalisation hits anticlimatic moment
As promised by the People’s Bank of China governor Zhou Xiaochuan two years ago, the vow for interest rate liberalisation has become reality on paper in China.
With the removal of the maximum cap allowed for deposit rates late last week, mainland Chinese banks are now free to compete for deposits and lending business by setting what deposit rates they want to provide to customers and the rates they would like to charge borrowers in lending which will impact the interest margins for their bottom line.
It is an anticlimatic end to an era of static state-mandated pricing, and a crowning achievement on Zhou’s tenure. But two days into implementation, the reaction among banks has been subdued.
There has been no rate war among banks fighting for deposits. Given the general lack of demand for credits under a struggling economy, all economists the South China Morning Post spoke to said they expect limited near term impact in the market for the banking sector and the distorted manner banks currently allocate credits will stay unchanged.
Nathan Chow, economist at DBS said real funding costs for mainland enterprises is over 10 per cent in China after factoring for inflation. The pressure on market funding is unlikely to see any relief in the next 12 months - as the implicit guarantees still distort true risk pricing.
“Over 50 per cent of total social financing is still dominated by bank financing in China. Direct financing provided by equity and debt capital markets, in comparison, make up less than 20 per cent. Too much risks remain concentrated in the banking sector.
And within the banking system, state-owned banks continue dominate. They are incentivised to apply their resources to state-owned enterprises. For as long as the state does not remove the system of implicit guarantees, the government will still ultimately have to bail out the SOEs. The reform may just eventually end up providing double the work but resulting in half the results,” Chow explained.
Banks will still give lending preference to state-owned enterprises; with private businesses seeing restricted and high-priced access to credit.
The picture will stay the same unless more serious structural reforms are pushed through. But over the longer-term, experts say a rate disruption could result in more Chinese corporates, which are now among the world’s most indebted borrowers, seeing repayment issues and small and medium-sized banks going under.
Chi Lo, senior economist for Greater China at BNP Paribas Investment Partners said: “People take the liberalisation for granted. I personally feel it is impossible. It has been achieved on paper. But in reality, when you look at who are the borrowers taking funds at discount rates in China, these are SOEs and government-backed entities that still dominate over 50 per cent of investment outputs in the economy - they need cheap credit for investments. So even if the rates are liberalised, there will still be a benchmark rate for these privileged borrowers.”
He said even though the benchmark deposit rates have now become non-binding and bank deposit rates are supposed to go up, these are just not moving.
“So ask who are the beneficiaries out of the liberalisation - there is just no satisfactory answer. But it is a right step to remove the deposit rate cap now. At this point of the economic cycle, the public’s confidence on the economy is low,” Lo said.
He added: “Most people have been losing money over the past few years. So there is no pressure on banks to hike rates at this pint. The fight for funds among banks is just not happening. There has been no sign that bank deposits have seen significant outflow to other alternatives. The threat is not there to implode the banking system or squeeze bank margins.”
Raymond Yeung, senior economist at ANZ, said: “You can use higher rates to attract market deposits. It is very normal to do so. But banking competition is not straightforward in China. Even if small, medium sized banks lift rates, the big five state-owned banks still have controls in attracting funding.”
Concurrently, the PBOC is currently circulating a guidance document among banking circles in China. It will soon set up a benchmark interest rate for market guidance, similar to the Federal fund rate used in the US, which it currently lacks. Economists said the PBOC’s reverse repo and rates used under its standing lending facilities are the most likely candidates for this role.