China's central bank announced interest rate reforms on Friday that are a milestone in China's financial marketization. It removed the floor on lending rates, allowing banks to cut rates as much as they like to attract customers, scrapped the controls on bill discount rates and lifted the ceiling on lending for rural banks. However, it did not remove the ceiling on deposit rates.
The long-term benefits of lifting controls on lending rates cannot be underestimated as it is the start of China's market-oriented reform of its financial market. Before the latest reforms the interest rates for both loans and deposits had controls relating to the benchmark rate and were strictly regulated by government.
The long-term benefits of lifting controls on lending rates cannot be underestimated as it is the start of China's market-oriented reform of its financial market. Before the latest reforms the interest rates for both loans and deposits had controls relating to the benchmark rate and were strictly regulated by government.
Meanwhile, the central bank's relaxation on bill discount rates means that banks can set their own prices. This change is good for guiding the market to use the Shanghai Interbank Offered Rate in the interest rate pricing process, which is a market-oriented practice, rather than using the benchmark interest rate as before.
Moreover, such a change will help promote interest rate liberalization. The central bank, instead of relying on the open market, can widely use the short-term interbank offered rate to regulate market liquidity as developed countries do.
The reforms mean banks will now give risk pricing to different borrowers based on their credit situation. However, this means banks will need to improve their risk pricing ability, which requires the establishment of an effective credit appraisal system as well. This will allow banks to compete on price.
Interest rate liberalization in China is being carried out gradually, and to some extent, that is why many problems in financial market exist.
The key is freeing deposit rates. A liberation of deposit rates would force banks to carry out effective risk pricing considering the floating costs and make them more cautious and rational in their commercial activities. Therefore, after removing the control on the interest rates for lending, China should seek to liberate the deposit rates in a timely manner.
Source: Xinhua
