China will probably wait at least two years before requiring banks to pay market rates on deposits as officials seek to avoid disrupting the banking system while the economy is slowing.
Policy makers will remove all restrictions on deposit rates in 2016 or later, according to seven of 12 economists and analysts surveyed by Bloomberg News from Sept. 9 to 13. Most respondents said such a move could cut net interest margins, a measure of loan profitability, by at least 50 basis points and smaller banks will be the hardest hit.
Freeing up the rates will subject the nation’s 3,800 banks to greater competition, forcing them to pay savers more to retain their share of the country’s 101 trillion yuan ($16.5 trillion) in deposits. That will aid Premier Li Keqiang’s goal of promoting consumer spending as a driver of the economy, which is headed for the slowest growth in 23 years.
“The key immediate impact would be a shift of income to households from banks,” said Wang Qinwei, a London-based economist at Capital Economics Ltd. That “will hurt the profitability of the banking sector, but will be critical in rebalancing the economy toward consumption.”
Combined profit at Industrial & Commercial Bank of China Ltd. and the other 15 publicly traded banks on the mainland rose 13.6 percent in the first half from a year earlier to $101 billion, data compiled by Bloomberg show, as the government-set rates preserved banks’ lending margins.
The earnings accounted for more than half of the total net income of China’s more than 2,400 listed companies. It also exceeds the $82.5 billion earned by 7,000 U.S. banks, Federal Deposit Insurance Corp. data show.
Respondents were divided on measures that China will take before embarking on full deposit rate liberalization. As a next step, policy makers will probably allow banks to issue certificates of deposit that offer higher rates for large amounts of savings, seven respondents said. Four people said the setting up of a deposit insurance system will be next.
Full deregulation of interest rates could shrink the sector’s average net interest margins by 50 to 100 basis points, six respondents said. Three said the magnitude of the drop will be 10 to 50 basis points and another two predicted a reduction of 100 points or more.
The net interest margin at the nation’s 3,800 lenders widened to 2.59 percent in the second quarter from 2.57 percent in the first, China Banking Regulatory Commission data show.
Meanwhile, Chinese savers are seeing the value of their funds being eroded as deposit rates fail to keep pace with inflation. The monetary authority caps returns on deposits at 1.1 times its benchmark rates. Deposits with a one-year tenure currently pay 3 percent and savers receive 0.35 percent for demand deposits, similar to a checking account, while the government’s inflation target for this year is 3.5 percent.
The central bank will allow trading of certificates of deposit between banks in the “near term” as it creates conditions for relaxing control over rates, Hu Xiaolian, a People’s Bank of China deputy governor, said in a Sept. 24 speech.
China’s central bank has already begun freeing up interest rates this year by removing a floor on what banks can charge for loans. Revamping deposit rates is the “riskiest” part of reforms leading toward full interest rate liberalization, and would carry a “much more profound impact,” the central bank said July 19, when it allowed banks to freely price loans.
“This is long overdue,” said Chris Leung, an economist at DBS Bank Hong Kong Ltd. and one of five respondents who predict interest rates will be fully driven by market forces before 2016. “We do not expect any shocks other than profitability of state banks will dis-inflate over time.”
It will be “unforgivable” if policy makers fail to set deposit rates free in five years, Fred Hu, founder of private-equity firm Primavera Capital Group and former Greater China chairman at Goldman Sachs Group Inc., said in an Aug. 15 interview in Beijing. China must learn from mistakes in the past decade when it put too much focus on downside risks, leading to delays in reform, Hu said.
Banks may be motivated to pile up riskier assets such as off-balance sheet loans when funding costs are no longer controlled, according to Xu Gao, a Beijing-based economist at Everbright Securities Co.
Shadow banking, which includes wealth management products, entrusted loans, trusts and underground lending, has raised concerns from regulators that it may destabilize the economy. The sector was valued at $6 trillion by JPMorgan Chase & Co., or 69 percent of China’s gross domestic product in 2012.
“Banks’ asset portfolios will be more skewed to high-yield, low-quality assets in their efforts to search for yields,” Xu said. “Small banks are in a disadvantaged position in the competition, so they are more aggressive.”
Ping An Bank Co. and China Minsheng Banking Corp. are among smaller lenders that expanded loans off their balance sheet last year, increasing the assets more than fivefold, according to exchange filings.
With fewer branches to attract savers, small banks have relied on funding from sources such as wealth management products, which pay higher rates than bank deposits. They have often tapped interbank markets for short-term financing to pay redemptions on the wealth products.
In June, the central bank refrained from injecting funds in the interbank market, leading to the country’s worst cash crunch in at least a decade.
The small banks “have been required to self-protect through the central bank’s stress test,” said Aidan Wang, Taipei-based economist at Yuanta Securities Investment Consulting Co. Wang also predicts that full interest rate deregulation may cut GDP by 0.25 percentage point.
Gross domestic product in the world’s second-largest economy will probably expand 7.6 percent this year, the slowest pace in more than two decades, according to the median estimate of economists surveyed by Bloomberg. Overcapacity in sectors such as steel, solar power and shipbuilding has led to slower growth and rising bad loans.
ICBC led the nation’s biggest state-controlled lenders in posting record combined net income of 216 billion yuan in the first half, an increase of 15 percent from a year earlier. They defied an earnings slowdown by boosting higher-yield loans to small firms while stepping up credit-risk management and nonperforming loan disposal as well as recovery.
Shares of the five biggest Chinese banks are still trading near record-low valuations on concern that interest rate deregulation could increase funding costs and slow the economy, leading to more defaults by borrowers.
Before deposit rates can be freed up, banks need to better reflect risks when they set lending rates, said Jim Antos, a Hong Kong-based analyst at Mizuho Financial Group Inc.
Lenders should downgrade the status of loans “based on economic reality rather than political considerations,” Antos said. “This is a concept they talk about on the mainland but as yet do not understand.”
— With assistance by Jun Luo, Aipeng Soo, and Stephanie Tong