Shanghai free-trade zone approved to pioneer interest rate reform
The People’s Bank of China has announced the removal of a cap on the rates of interest paid on foreign currency deposits in Shanghai’s free trade zone.
In a move aimed at speeding a reformation of the interest rate system, the central bank will now allow zone-based banks to have no ceiling on the rates for deposits of less than $3 million. This will apply to deposits by individuals who have worked in the free trade zone (FTZ) and to companies that are registered inside.
China’s central bank currently has around $4.8 billion in foreign currency deposits, including around $1.2 billion in deposits under $3 million.
Shanghai’s 28.78 square kilometre FTZ was established in September 2013 in a bid to test moves to reduce the Chinese Government’s role in setting interest rates and in conversions of the Yuan.
The FTX is expected to increase competition with Hong Kong by increasing China’s prowess and ability as a hub of international finance and trade, helped by a free exchange of all currencies.
The move to lift the cap on foreign deposits aims to increase global resources within the second largest economy in the world and halt the recent economic slowdown.
It is now likely to be implemented across China, but the head of the Shanghai branch of the People’s Bank, Zhang Xin, has urged banks to protect themselves against outflows of these deposits and prevent a volatile rates environment.
More reforms on the cards
The cap was removed on March 1, 2014, and has already paved the way for more liberalisation of interest rates within the FTZ.
Banks inside the FTZ are now able to pay clients as much interest on deposits as they want after the Chinese Government announced that it will allow banks even greater power in setting interest rates. It also announced the introduction of a deposit insurance system.
The deposit insurance is aimed at minimising any risks associated by rates not being set by the government and will bring China into line with other Asian economies.
It is likely that banks will not have to pay market rates on any deposits for around two years in a bid to avoid causing too much disruption to the banking system. The People’s Bank had already moved towards more freedom in relation to interest rates by removing a limit on what banks can charge for loans.
The central bank started what is known as a ‘loan prime rate’, a figure based on the charges made by nine large Chinese lenders to their best clients. It also now allows banks to sell certificates of deposits that are negotiable and have their yields decided by the market.
The complete deregulation of the rates on deposits is likely to cut the net interest margins of banks by 50 basis points or more.
These margins are a measure of the profitability of loans and it is expected that some banks will suffer as a result of an introduction of a greater dependency on market rates.
Simon Ho, an analyst at Citigroup Inc, has predicted that because there will be a charge for the new deposit insurance scheme, Hong Kong-listed Chinese banks may see their profits reduced by five per cent.