Mon, Dec 16, 2013

http://blogs.wsj.com/chinarealtime/2013/12/12/china-quickens-the-pace-in-financial-reform/

China is moving along on its long march to free up interest rates, a key part of financial reforms. This week it picked up the pace a bit.

On Thursday, five big banks issued the nation’s first interbank negotiable certificates of deposit, marking a small but important step in interest-rate liberalization. They issued a total of 19 billion yuan ($3.1 billion) in NCDs—the largest of which were for 5 billion yuan each by China Construction Bank and the Bank of China. And hot on their heels, five mid-sized banks announced plans of their own.

The moves came just four days after the People’s Bank of China gave the final go-ahead for the much-anticipated policy shift. And they follow a November meeting of top Communist Party officials that unveiled a blueprint for economic and financial reforms over the longer term.

China has long had its eye on giving the market a bigger role in determining domestic interest rates, and the central bank has been gradually stepping back from its role in setting them. After seemingly endless discussion and research, the PBOC scrapped its floor on lending rates in July after giving banks a little more room to set deposit rates last year.

NCDs are a tool for banks to lock in funds from other banks, helping them manage liquidity. Interest rates on these instruments are negotiated by the banks themselves and aren’t subject to guidelines set by the central bank. For the first batch of these interbank products, a one-month NCD fetched 5.10% on Thursday, while a six-month instrument carried a rate of 5.25%.

The NCDs don’t directly affect consumers—but products that do probably aren’t far off. Next year banks are likely to issue large certificates of deposit for individuals and companies, and these too will have interest rates that fall outside the central bank’s deposit-rate guidelines.

For years, depositors have had to settle for lower rates on their traditional deposits as the central bank took care of its state-run commercial banks, keeping a hefty spread between rates on deposits and loans. The central bank benchmark calls for a 3% interest rate on a one-year deposit, and banks can pay up to 3.3%.

These relatively low deposit rates have led to the rapid growth in so-called shadow banking—the nontraditional financial system that operates alongside the banking sector. Wealth-management products, which are not technically deposits but which banks can offer, carry considerably higher rates and have become hugely popular with customers. For savers with a minimum of 50,000 yuan, these products offer returns of 5%-6% at the banks; trust companies offer even more for a somewhat higher degree of risk.

The faster pace in rolling out these latest reforms is good news for a host of other measures that have long been in the planning stage. China is getting ready to open the door to more private capital in the banking sector while also moving closer to unveiling a deposit-insurance system and a financial bankruptcy law—two essential building blocks for a liberalized banking system.

The arrival of the negotiable certificates of deposit may not give consumers too much to cheer about just yet. But they are an important signal of things to come.