As China prepares to liberalize interest rates, the experiences of the United States and other countries may offer some timely lessons.
Commercial banks in China offer a maximum of 3.3 percent on one-year deposits. The People's Bank of China's (PBoC) benchmark deposit rate stands at 3 percent, and banks can offer up to 10 percent more than the benchmark. This means that the real market rate from commercial banks is currently around 3.3 percent. This practice is similar to Regulation Q in the United States before it was abolished in 1986.
Regulation Q prohibited U.S. banks from paying any interest on demand deposits and gave the Federal Reserve the power to set interest rate ceilings on time deposits.
Banks make fat profits from wide spreads between low deposit rates and high lending rates. China scrapped the lower limit on lending rates in July 2013. Deposit rate reform will be the last -- and most important -- step in liberalization.
Zhou Xiaochuan, PBoC governor, suggested last month that China may ease deposit rate controls in the next two years, the clearest reform timetable yet.
There are many similarities between China's money market funds (MMFs) today and U.S. MMFs before Regulation Q was repealed. Depositors seek higher returns elsewhere when bank deposit rate ceilings are in place, Sun Tao, senior economist with the International Monetary Fund (IMF), told Xinhua.
China's interest rate liberalization has been partly expedited by fast development of MMFs like Yu'ebao. With returns of nearly 6 percent, Yu'ebao amassed 81 million clients in just nine months.
Nicholas Borst of Washington's Peterson Institute for International Economics notes that in the United States regulations put in place after the Great Depression to protect banks were slow to adapt to an evolving financial system. As a result, other financial institutions began offering MMFs at rates more in line with prevailing short-term market rates, much as is happening in China today.
Source: Xinhua
