By Yi Xianrong, Global Times
Speaking at last month’s Boao Forum for Asia in Boao, South China’s Hainan Province, China’s newly appointed central bank chief, Yi Gang said the country will continue with market-based interest rate reform. China still to a certain extent uses a dual-track interest rate system, with deposit and lending rates set with reference to benchmark rates while money-market rates are decided entirely by the markets.
The country has now loosened its grip on deposit and loan rates, with commercial banks allowed to set their own interest rates based on the benchmark rates. This will allow the two parallel tracks to be gradually combined into one.
Also last month, the loosening of ceilings on deposit rates was discussed at a meeting of members of the country’s market interest rate pricing self-disciplinary mechanism organization, yet another sign that market-oriented interest rate reform has become the focus of China’s financial markets.
By rights, domestic interest rates should already be market-based, considering that the central bank removed a floor on bank lending rates in July 2013 before lifting the ceiling on bank deposit interest rates in October 2015. But there’s still a huge gap in liberalizing interest rates between China and mature markets, because the domestic banking system remains dominated by State-owned banks.
There is still unofficial government interference in interest rates, and the defects of China’s financial market interest rate system have also resulted in many problems.
For instance, State-owned banks can be directly mandated to price loans offered to companies that are favored by the government on the basis of industrial policies and the companies’ ownership structure. Also, deposit rates remain under the purview of the central bank’s window guidance and the market interest rate pricing self-disciplinary mechanism, which means commercial banks can’t attract deposits by offering interest rates higher than those agreed on by the self-disciplinary mechanism.
These conditions are unfavorable for China’s move toward genuine market-based interest rates. However, if the country steps up interest rate liberalization and removes so-called “self-disciplinary” restrictions, unofficial interference with deposit and lending rates will be reduced, and this will have a profound impact on the country’s financial markets.
Serious defects in the nation’s financial market interest rate system also pose a problem for market-based interest rate reform. It can be seen that even in an era of digital currencies and digital payment systems, central banks still must pursue clear and definite monetary rules to ensure stable price levels.
Central bank-controlled benchmark rates are the major tool a country uses to achieve this target. Benchmark rates are generally money market short-term rates, at least in a mature financial market. Such rates are seen as reflecting supply and demand.
The impact on the market of benchmark rates goes beyond the actual rates themselves. The benchmark rates, by means of a transmission mechanism, affect a variety of values in the financial markets such as long-term interest rates, stock prices and exchange rates. Benchmark interest rates play a forward-guiding role and highlight central bank expectations.
Companies and individuals can base decisions on the information that central banks disclose in this manner, reducing risks and uncertainties associated with companies’ investment and individuals’ consumption.
China’s market-oriented interest rate reform will entail establishing a trading market that is fair, just, transparent and fully competitive. This means liberalization of deposit and lending rates, which will give financial institutions more leeway in setting prices.
China should also put in place a regime for central bank policy interest rates and create a new benchmark interest rate system to guide and regulate market rates. Without a refashioned benchmark interest rate system, there is no way to price financial assets, and changes in supply and demand of funds won’t be reflected in financial product prices. In such a case, market-based interest rates are meaningless.
Creating a new benchmark interest rate system will become the most important part of China’s interest rate liberalization.
The author is a professor with the School of Economics at Qingdao University. [email protected]