1050x300-LMK-Working Paper-Bank Readiness for Interest Rate Liberalization in China

Working Paper: Bank Readiness for Interest Rate Liberalization in China

Author(s): Liu Mingkang

Date: Aug 30, 2013

Theme(s): China, Finance & Macroeconomics

Publications: Project Documents

Distinguished Fellow Liu Mingkang looks at how Chinese commercial banks have responded to policy initiatives relating to the interest rate liberalization process.

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On June 8 and July 6, 2012 respectively, the People’s Bank of China (PBOC) adjusted the renminbi benchmark deposit and lending rates as well as the caps and floors on such rates. Currently, the cap on bank deposit rates has been raised to 110 per cent of the corresponding benchmark rates and the bank lending rate floor was lowered to 70 per cent of the corresponding benchmark rate. These two adjustments on interest rates were important steps in advancing the process of interest rate liberalization in China.

According to the Chinese Bankers Survey (2012), jointly conducted by the China Banking Association and PricewaterhouseCoopers (PwC), the adjustments at that time caught the market by surprise. We can infer that the PBOC drove the interest rate liberalization program, with the commercial banks only reacting to the policy initiatives. In the 10-month period since the 2012 liberalization, we have examined how Chinese commercial banks have responded to the policy initiatives and readied themselves for the current interest rate liberalization process. The survey was conducted by interviewing senior bank executives, with the sample covering 6 large commercial banks, 7 joint-stock commercial banks, 4 city commercial banks, 2 rural commercial banks and 10 foreign banks.

The survey revealed that the present impact of the interest rate liberalization process was mainly on business operations, but that on the whole, the pace of liberalization was moderate, with acceptable and manageable impact on the commercial banks.

The commercial banks made a number of satisfactory preparations to ready themselves for the liberalization process.

  • In the area of business operations, the main strategic adjustment was to enhance innovative capacity, allocating more resources for new businesses and new products. To promote innovation in new product lines and financial instruments, the key measure was to improve market research and understanding of competition from other banks. The specific internal and external barriers to innovation capacity were respectively shortages in professional skills and the under-developed financial infrastructure.
  • In the area of risk management, the preferred strategy was to pursue price differentiation and risk- adjusted product pricing. Here, the main internal and external barriers to further innovation in risk- adjusted pricing were respectively data inadequacies and flaws of the quantitative models and the incomplete base rate and market guidance/rate transmission mechanism.Furthermore, the survey indicated that the main barriers to interest rate liberalization are the incompleteness of the base rate system which in turn limits the effectiveness of the interest rate transmission/price formation mechanism. Measures to promote the unification of interest rates in the bond market, increasing the number of banks quoting SHIBOR, and enhancing the supporting transaction/dealing functions would be important to improving the base rate transmission process.

 

The views expressed in this article are the author’s own and do not necessarily reflect Fung Global Institute’s editorial policy.