It’s good to remove the loan-to-deposit ratio cap

On June 24, the State Council approved a draft amendment to the commercial banking law that would scrap the 75% of loan-to-deposit ratio used to control market liquidity. The change will likely be approved by the top legislature in August and take effect next year. In fact, all sectors of society appealed to abolish the LDR cap very early. It is unexpected that the day came so quickly.

LDR cap once has been the progress of China’s bank reform. Before 1995, loan release of banks was directly under the guidance of government administration, and bank operation had no independence. This made the economy into the doomed cycle whereby power delegation leads to market disorder which, in turn, leads to tighter control. As the central macro-control system became indirect and market-oriented, bank reform also gradually emphasized autonomy, and the central bank abandoned direct intervention in banking business, and used the LDR and other indicators to indirectly regulate bank credit and control liquidity risk.

After the establishment of the indicator of LDR, the vast majority of banks were not in line with the standard. The LDR of Hainan Development Bank which bankrupted in 1998 was as high as 136%. After the Asian financial crisis, with the deepening of the reform, the LDR of the banking industry began to decline. Even during the economic prosperity, the LDR of big banks has been decreased to 60%.

In a very long time, the LDR has not become a constraint for the banks to develop business. Only the LDR of some small and medium-sized banks was likely to reach the upper limit of more than 75% because they had limited branches, and cannot absorb enough deposits while lending relatively too much.

Objectively, the LDR emphasizes “loan can be released only when there is deposit”. Therefore, banks place high value on deposits and require its employees to attract designated deposits amount. While when the deposit reserve rate and the credit growth remains stubbornly high, the deposits under the constraint of the LDR is extremely important, which is one of the reasons why the yield rate of wealth management products and monetary fund is high in recent years.

From today’s perspective, the LDR is a backward liquidity regulatory indicator. When finance was not market-oriented, the liability of banks was mainly deposits, and the LDR was also able to reflect assets and liabilities of banks. But now with financial liberalization and financial disintermediation, the source of funding for banks is increasingly diverse and LDR has been unable to adapt to such changes. Last year, the CBRC also adjusted the constituent of the numerator and denominator of the LDR so as to adapt to the new situation.

Now the banks have not been able to release loans when there are deposits; the scale of loans is also subject to the capital of the banks and other indicators. When there is no sufficient capital, banks can not release loans. In addition, bank operation has great independence. When the economic situation is not good, banks are not willing to release loans.

When only talking about liquidity regulation, since the subprime crisis in 2008, Basel III that introduced liquidity coverage rate, net stable funding ratio and other indicators, is far superior to the relatively extensive LDR in risk regulation. Since 2013, the China Banking Regulatory Commission also asked the banking industry to start to implement “Basel Agreement III”, and the LDR will be abolished sooner or later.

After the abolition of the LDR, subject to economic situation and the capital of the banking industry, the scale of bank credit is unlikely to advance rapidly. Its growth depends on the central bank’s monetary policy.

The good news is that it is unnecessary for bank staff to take deposits with high interest. Small and medium-sized banks can adopt more diverse liquidity supplement programs, and they do not need to worry about “fewer branches, hard to take deposits and release loans”. The yield rate of wealth management products and monetary funds will also subsequently drop. It’s time for banks to consider how to improve their asset management and operation level.

Published in Oriental Morning Post | 2015-6-26