When China’s central bank
announced last August that the loan prime rate would become the new benchmark for bank lending, the market regarded it as a milestone move towards full liberalisation of interest rates, which would allow commercial banks to price deposits according to their discretion and risk appetites.
As such, it seemed that official deposit rates – including the benchmark one-year deposit rate – would soon disappear from China’s banking industry. In fact, the People’s Bank of China (PBOC) has not touched these traditional policy rates since October 2015.
Yet recently, there has been talk among investors that China could opt to cut the official one-year deposit rate, to lower the cost of funds for
coronavirus-hit companies. Such a policy move feels increasingly imminent after senior PBOC officials and advisers hinted publicly that the central bank could lower the rate.
Ma Jun, a PBOC adviser, said early last month that China should consider lowering the benchmark deposit rate, as the fast-spreading coronavirus epidemic left
smaller businesses struggling.
On February 22, PBOC deputy governor Liu Guoqiang said the central bank will free up part of the reserves of some commercial lenders for long-term funding to the economy, and consider adjusting the benchmark deposit rate at an appropriate time.
It would be a real surprise to many if the PBOC were to cut the rate, as recent reforms suggest China is pushing ahead with the
liberalisation of the interest rate regime. As such, the central bank is unlikely to want to directly guide lending and deposit rates for commercial banks and would instead conduct open-market operations and use other market-based instruments to indirectly influence the rate dynamics.
Moreover, the effectiveness of such a cut looks questionable, given that the PBOC has significantly relaxed the deposit rate ceiling for commercial lenders to 1.5 times the benchmark one-year rate. Many banks are still
offering incentives such as cash and shopping vouchers to attract deposits.
However, the
urgency to lower the cost of funds for the real economy seems to have pushed the Chinese central bank to consider every possible option.
According to the central bank, actual lending rates for coronavirus-hit corporations should be below 1.6 per cent. Assuming the government subsidises half of the interest expense, commercial banks can charge only a maximum of 3.2 per cent. As the
one-year loan prime rate is 4.05 per cent, there is a gap of at least 85 basis points that needs to be closed.
The PBOC could lower the loan prime rate again over the coming months to influence the lending rates, as it
did on February 20. Still, if the actual cost of deposits for commercial banks remains sticky, a loan prime rate reduction would only be symbolic.
The cost of deposits varies among banks but we can use the yield of the money market fund
Yu'e Bao as a proxy, as it is one of China’s most popular outlets for people to “deposit” idle cash.
As of February 28, Yu’e Bao’s seven-day annualised rate was 2.31 per cent, well above the benchmark one-year deposit rate of 1.5 per cent. More importantly, although China’s central bank has conducted many easing operations over the past two years, Yu’e Bao’s yield has been stable since late 2018, which to a large extent reflects the sticky cost of deposits for commercial banks.
Chinese policymakers looking to lower the cost of loans for the real economy cannot simply force banks to reduce the price of loans, as this impairs banks’ buffers and their
ability to withstand shocks, particularly in an economic downturn. As such, a reduction in policy deposit rates becomes an action point for the PBOC.
All told, the recent talk about official deposit rate cuts in China may look odd but it really points to the urgency of supporting the struggling economy through policy measures.
Hao Zhou is senior emerging markets economist at Commerzbank
