China Needs 2 Years to End Interest Rate Regulation, Lian Says

China may need at least two years t0 end government control of interest rates and full deregulation may narrow banks’ net interest margins by one-third, Bank of Communications Co. predicts

As their next steps, policy makers are likely to remove restrictions on the rate banks pay for five-year deposits and allow lenders to issue certificates of deposit that offer higher rates and can be sold on a secondary market, Lian Ping, Shanghai-based chief economist at the bank known as Bocom, said at a briefing today. Five-year term accounts are about 3 percent of total deposits, Lian said.

The People’s Bank of China on July 20 scrapped the floor on the lending rates banks can charge customers, in the biggest step to move the nation’s financial system toward rates set by the market. The central bank left the cap on deposit rates unchanged on concern that removing it without further preparations could lead to financial turmoil.

The government must also make more changes before setting up a deposit insurance system, Lian said, adding that the move may lead savings to flow from smaller to larger lenders.

Full interest rate deregulation may reduce the industry’s net interest margin by 100 basis points to about 2 percent, Lian estimated. Together with other factors such as rising defaults and competition from non-bank financing, China’s banking industry will face “extraordinarily severe” challenges in years to come, he said.

The Communist Party’s Politburo Standing Committee, China’s top decision-making body, called on authorities to be on guard against risks from the financial sector in April as the nation seeks to stabilize growth, which is on pace this year for the slowest expansion in 23 years. China’s National Audit Office announced July 28 that it was starting a nationwide review of local government debt.

Local governments’ financing vehicles may have at least 12 trillion yuan ($2 trillion) of debt, with the peak of repayments coming in the fourth quarter, Lian said today.

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