China’s central bank eases its grip on interest rates, a bit
By V.V.V. | SHANGHAI
ADVOCATES of financial liberalisation in China will remember July 20th as a special day. The People’s Bank of China (PBOC), the country’s central bank, announced that it will immediately end all restrictions on lending interest rates. In other words, China’s banks are now allowed to set those rates as they see fit.
Many analysts did not expect the PBOC to go this far this fast. A few weeks ago its clumsy attempt at reining in dodgier sorts of bank lending led to a credit squeeze and market panic. And yet, it is willing to take a bold step shortly after that debacle.
By removing the floor on commercial lending rates, previously set at 70% of the PBOC’s benchmark lending rate, officials hope to increase competition among banks and spur lending to the corporate sector. With economic growth slowing down, private firms in particular could use greater access to credit.
This is good news, but it is only the first—and a relatively easy—step in a difficult journey. The bigger prize for reformers is the liberalisation of interest rates paid on bank deposits. Those rates, the PBOC made clear in its announcement, will remain under tight control for the time being.
This is a pity, but the big banks are surely breathing a sigh of relief. For years they have enjoyed what is essentially a licence to print money. Banks are only allowed to pay very low or even negative real rates of interest to depositors. At the same time, banks are required to funnel that money at preordained higher rates to favoured businesses, mainly state-owned enterprises (SOEs).
The financial repression guaranteed profits for banks and an easy life for bankers, but made savers lose money. That pushed them to invest in riskier assets, not least property, to defend the value of their hard-earned earnings—which explains, in part, why China is trapped in a property bubble.
Worse, because banks were under orders to support SOEs, they handed out credits without much due diligence. This has left many banks without the skills and systems needed to assess credit risk. And since private firms, particularly small and medium enterprises, have been unable to get much credit from official banks, they have turned to informal lenders—which has spawned a murky shadow banking system.
All this explains why the liberalisation of the lending rate is but a half measure. It is understandable for China’s leaders to proceed methodically with market reform, given the risks involved in getting it wrong. But they should remember that excessive caution can also be dangerous: it would allow enemies of reform—in this case the big banks facing a profit squeeze and SOEs confronting a credit squeeze—to gather forces.
Under the previous leadership of Hu Jintao, caution turned into inaction and reform stalled for years. If the new government of Xi Jinping wants to avoid a similar legacy, it must quickly build on this welcome new measure with bolder and broader reforms.
