China's central bank leads reform

The People's Bank of China has not been shy at leading change. Photo / AP
The People's Bank of China has not been shy at leading change. Photo / AP

Nobody can accuse the People's Bank of China, China's central bank, of being gun-shy. A few weeks ago its clumsy attempt to restrain dodgier forms of bank lending led to a bout of market panic.

Many said the episode would chill enthusiasm for further experimentation.

But on July 20 the PBOC experimented again. On that day the central bank ended all restrictions on lending rates, which previously had a floor of 70 per cent of the PBOC benchmark rate. Banks are now free to set lending rates (save those for residential mortgages) at any level they want.

In truth, the measure is less bold than it appears. The interest-rate reform that everyone is waiting for is liberalisation of deposit rates.

China's policy of financial repression has capped the rate that banks can pay depositors, even as it put a floor on the rate at which they must lend. That has guaranteed fat profits for the big state banks, like Bank of China and the Industrial and Commercial Bank of China, that dominate the system.

The liberalisation of lending rates may be a half-measure, but officials still hope it will increase competition among banks and spur lending to the corporate sector, especially to private firms that have long been starved of capital.

Sceptics point out that the PBOC moved the floor for the lending rate from 90 per cent of its benchmark to 70 per cent a year ago, but Chinese banks did not rush to lend below the 90 per cent mark. That suggests they are unlikely to cut rates now.

A rival view argues that borrowers with strong bargaining power, such as big state-owned enterprises (SOEs), will now be emboldened to push the big banks for cheaper loans. Some suggest that non-performing loans at SOEs may be rolled over at negligible interest rates, disguising what is, in effect, a state bail-out.

On this view, as lower rates eat into their profits the big banks will be forced to look for higher-margin opportunities at the small and medium-sized private firms they have long ignored. That, in turn, will put them in direct competition with smaller, private-sector joint-stock banks, such as China Merchants and China Minsheng, that have focused on this area.

If so, China's banks may be about to enter a rocky period. ChinaScope Financial, a research firm, has analysed how increased competition and declining net interest margins will affect banks operating in China. The boffins conclude that the smallest local outfits, known as city commercial banks, and the middling private-sector banks will be hit hardest, but that returns on equity at the big five state banks will also be squeezed.

The bigger worry for China's state banks is the signal sent by the PBOC's move. The central bank has affirmed its commitment to reform. If those reforms include the liberalisation of deposit rates, something more serious than a minor profit squeeze will befall China's banks. Guaranteed profitability would end; banks would have to compete for customers; and risk management would matter. In short, Chinese bankers would have to start working for a living.

- NZ Herald

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