China’s Interest Rate Liberalization should set a Timetable
On June 7, the People’s Bank of China (PBoC) announced to cut interest rates for savings and loans by 25 basis points and at the same time loosen the loan interest rate floating range, namely “Adjusting the floating range of the upper limit of the benchmark interest rate for the financial institutions by 1.1 times and the lower limit by 0.8 times.” Soon afterwards, the five major state-owned banks immediately floated their interest rates for savings of one year and less than one year, and many other urban commercial banks followed suit by floating their deposit interest rates up to the upper limit.
In the first half of this year, economic data has showed poor performance for months and the market has psychologically prepared for the arrival of a loose monetary policy, yet has not expected such a faster interest cut. Actually the timing for the interest cut affirmed the proper judgment of the slowdown of the economic growth on the part from the PBoC. However, most importantly, the asymmetric interest rate cut might trigger off many different market conjectures as this approach was an exceptional policy in recent decades, permitting commercial banks to have the deposit interest rate floated at unspecific targets. After the release of the policy, many banks gave the faster response to float their deposit interest rates up to the upper limit of 3.5% at the first time—the level equal to that prior to the cut, or even playing the policy to its full maximum by floating the rate up to 3.575%, which could totally offset the impact of the interest cut on deposits. Some experts even surprisingly claimed that that a furious deposit attraction war among banks will kick off, which will fully reveal the consequence of the current interest rate control: The oppressed interest policy will render the nominal interest rate far below the equilibrium rate of interest.
However, it might be overoptimistic to deem this asymmetric interest rate drop as the beginning of the interest rate liberalization. Though the current economic remains sluggish, the market capital is comparatively active and more and more deposits of residents move out of banks into non-bank financial institutions or shift into the wealth management business conducted by commercial banks, say, trusts, bank wealth management products and higher-interest usurious loans, etc. So as for the central bank, how to keep the deposits within the banks and at the same time lower the financing cost of enterprises remains one of the priorities for our monetary policies.
In another aspect, in recent years, banks have gained the astonishing profits, far more than those of other sectors either home or abroad. Yet these profits have nothing to do with their improvement of operational efficiency. Instead it is actually the abnormal interest spreads of deposits and loans under the interest rate control regime, thus banks are open to the criticism from people of all walks of life. The asymmetric interest rate cut, objectively speaking, narrows the rate spread on savings and loan and may restrain the abnormal profits generated by the interest rate control, thus mitigating the social accusation of the windfall profits obtained by the banks.
Therefore, one should not just take it for granted that the asymmetric interest rate cut manifested the intention of the PBoC to initiate the interest rate liberalization. Yet, it does not mean that the demand for the interest rate liberalization is not an urgent task. As we know, the price is the signal specifying the degree of scarcity of the materials or products available in the market, and our decision for the production and consumption can be thus made accordingly. However, the interest rates, acting as the most essential element—the price of the capital, for a long period, have been put under the stringent control, which had been resulted from the many plights bothering China, such as the imbalance of economic structure, asset-price bubbles, overinvestment and the widening income distribution gap and the phenomenon of “state-owned sectors advance while the private sectors retreat”, etc., all of which are ascribable to the slow progress of the interest rate liberalization. In fact, the slow progress has rendered it rather difficult for the government to make improvements in solving relevant problems. As a matter of fact, the interest rate control has become the most dangerous enemy against the long-term and sustainable economic growth.
The latest influential adjustment of the interest rate control policy occurred on October 29, 2004 when the PBoC raised benchmark interest rates for the financial institutions, which basically eased the control over the lower limit of deposits and the upper limit of loans, thus forming a regulatory system on “the lower limit of loan interest rates and the upper limit of the deposit interest rates” under the current interest rate control system. It was mainly intended to lower the overall interest rate level while guarantee the profitability of the banking sector and made up for the overdraft of the bank capital and their independent development due to the long lower interest spread of deposit and loan in order to win more time for the banking reform.
This control policy did achieve the initial goal and the banking sector realized their smooth restructuring and obtained the sharp profit gains, yet was not modulated on a timely basis. So during the subsequent period of nearly 7 years, the entire control framework didn’t have any noticeable changes, but the banks change their roles from the supported targets to the firm supporters of the current policies, and the similar policy beneficiaries and supporters include the central enterprises and local governments (typically the financing platforms controlled by the local movements), coupled with the real estate developers, exporter-orientated enterprises and capital-intensive manufacturing industries, etc. On the very contrary, the policy sufferers mainly include the residents with deposits in the banks and enterprises battered due to lack of capital, etc.
In fact, monetary authorities execute the interest rate control but it does not mean that the real interest rate in the market is truly controlled as expected. Capital will not remain idle. Particularly today when we have well-developed means of transaction, excessive regulations would only push the capital flowing out of the control of the authorities. Yet when problems appear, the regulatory authorities can not keep themselves out of the affair, which can be substantially evidenced by the risks of usuries in Wenzhou and other places. So even if this asymmetric interest rate cut is not a beginning of the further interest rate liberalization, the pace for the further interest rate liberalization will be not far away from us, but the key lies in what an interest rate liberalization model we will follow.
Interest rate liberalization is a systematic engineering as well as a policy adjustment of the domino effect, which can not be achieved at one stroke. We’d better take the benefits of the depositors for instance, after the liberalization of the interest rate control, the competition among banks will be severely intensified and some banks will drop out from the market due to the competitive failure. How can we safeguard the benefits of the depositors? It is quite necessary to establish the Deposit Insurance System. The deposit insurance can only cover the deposits less than a fixed quota while the risk beyond will borne by the depositors, which will facilitate the institutions and the high-end wealth group to have their investments diversified, thus the state level credit and the high-credit bond market will be urgently needed to undertake such diversified investment and the bond markets will be enlarged and upgraded accordingly.
After the liberalization of the interest rate control, it is necessary to establish the interest rate formation mechanism since the current liberalization system will fail to undertake such a heavy burden. The central bank should transform itself from the previous direct control player, particularly in the form of administrative orders, into an indirect policy adjuster and controller to promote the building of the transmission mechanism and other key factors, all of which will impose the great challenge to the progressive schedule of the interest rate liberalization.
Some other typical problems are worth our special attention: after the interest rate liberalization, the loan interest rates will go up, as for the state-owned enterprises typically supported by the financing platforms of the central enterprises and the local governments, how can they solve the financing problems related to their investment in future infrastructure? How can they dissolve the incremental financial cost for the currently existing loans? Do we have to continuously implement the dual interest-rate system or resort to other approaches? These are the questions to be urgently answered.
From a deeper perspective, the reason why the current interest rate control system proves comparatively effective primarily lies in such a series of implicit arrangements in which the banks’ State-owned property, restrictions of the market access and the national credit guarantee, etc., have played a decisive role. While these systems do no change, the interest rates will not be the market prices in a true sense even if the PBOC completely loosens the interest rate control. In other words, definite property rights, lower access threshold, free competition and the withdrawal mechanism are the prerequisites to further promote the interest rate liberalization.
Previous experiences and lessons remind us that if we want to succeed in promoting the interest rate liberalization, it is necessary for us to completely streamline or sort out the current systems and smoothen out the basic mechanism of the interest rate liberalization, and not to leave anything to be desired or treat the banks differentially, which may make our interest rate liberalization fall flat. Our views in this journal are that something must be properly done before we can reach this goal: First, a full discussion should be carried out nationwide to straighten out the advantages and disadvantages and reach a consensus at last; secondly, the reform should be carried out according to the road map and the timetable; it is necessary to have all preparations for interest rate liberalization and give the market the definite expectations so that the market can be well prepared for dissolving the impact of the interest rate liberalization; Thirdly, the reform should be conducted with resolutions and strategies, permitting no delays and any expectations for the overnight changes. Only such an interest liberalization modeled upon the above-mentioned ideas is worth our expectation.
First appeared in Lujiazui Review on Jun. 1, 2012
