China Pledges Deposit Insurance as Authorities Liberalize Rates

China plans to set up a system for insuring bank deposits this year as part of steps to reduce the government’s role in setting interest rates.

The government will introduce a deposit insurance system and banks will be granted more power to set interest rates as part of planned reforms of the financial sector this year, Premier Li Keqiang said yesterday in his state-of-the-nation address at the opening of the National People’s Congress annual sessions in Beijing. While China has said it plans to start deposit insurance, yesterday was the first indication of when it might be implemented.

Central bank governor Zhou Xiaochuan in November identified deposit insurance as a mechanism needed to handle risks as China moves to a system in which interest rates are set by the market and not regulators. The dominance of state-owned lenders has left savers believing in an implicit government guarantee though China is the only major Asian economy without a formal insurance system, according to Citigroup Inc.

The People’s Bank of China moved toward freeing up interest rates in July by removing a floor on the rates banks can charge for loans. Three months later, the central bank started a “loan prime rate” based on weighted average costs charged to the best clients by nine major Chinese lenders and in December, it allowed banks to sell negotiable certificate of deposits with yields set by the market.

Rate Caps

The PBOC currently caps returns paid on deposits at 1.1 times its benchmark rate, which stands at 3 percent for one-year deposits. China reported a 2.5 percent pace of inflation in January, with Premier Li yesterday setting the government’s 2014 consumer price index target at 3.5 percent.

Revamping deposit rates is the “riskiest” part of liberalization, and would carry a “much more profound impact” than lifting the floor on lending rates, the PBOC said in July.

China’s Communist Party, following a meeting of its central committee in November, pledged to give markets a “decisive” role in allocating resources. Policy makers have pushed to give private businesses a larger role to fuel expansion in the world’s second-biggest economy as rising labor costs and worsening pollution force China’s leaders to reduce their reliance on exports and investment for growth.

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, according to a Bloomberg News survey in September.

Guidance Book

In November, PBOC governor Zhou wrote in a “guidance book” that the planned deposit insurance system would cover all financial institutions with “limited compensation” and differentiated rates.

Full deregulation of deposit rates would cut banks’ net interest margins, a measure of loan profitability, by at least 50 basis points, and smaller banks will be the hardest hit, according to the Bloomberg News survey.

Banks probably won’t be able to pass the cost of insurance on to their customers, Citigroup Inc. analyst Simon Ho wrote in September. A 10 basis-point premium would reduce Hong Kong-listed Chinese banks’ 2013 profit by 5 percent to 7 percent, according to Ho.

Jim Antos, an analyst at Mizuho Securities Asia Ltd., estimated in a note Dec. 19 that the insurance system will reduce Hong Kong-listed Chinese banks’ earnings by 1 percent in its first year.

— With assistance by Jun Luo

Before it's here, it's on the Bloomberg Terminal.