(Updates with savings products in 11th paragraph.)
Dec. 9 (Bloomberg) -- Chinese banks’ funding constraints are set to ease after policy makers authorized the sale of certificate of deposits in a move toward loosening control over interest rates in the world’s second-largest economy.
The prices for negotiable certificate of deposits, or NCDs, will be set by trading on the interbank market, with the Shanghai Interbank Offered Rate used as a reference rate, the People’s Bank of China said in a statement yesterday. Deposit- taking firms are permitted to sell NCDs of at least 50 million yuan ($8.2 million) to other financial institutions under rules that go into effect today.
Shares of smaller Chinese lenders including China Minsheng Banking Corp. rose in Hong Kong trading today as investors bet that the NCDs offer a fresh avenue to raise money for the banks most dependent on interbank borrowing. The Communist Party, which pledged last month to give markets a “decisive” role in the economy, in July eliminated a floor on lending rates.
“It’s a step in the right direction,” Chris Leung, an economist at DBS Bank Hong Kong Ltd., said by telephone. The NCDs “will provide an additional channel for banks to attract deposits.”
Small and mid-sized banks in China, which have difficulty competing with larger rivals for deposits due to their lack of outlets, are likely to “actively” sell NCDs to raise funds, Li-Gang Liu, an economist at Australia & New Zealand Banking Group Ltd., said in a note to clients today. That will push up the cost of funds for Chinese financial institutions and corporate borrowers, he said.
Mid-sized banks gained in Hong Kong today. Minsheng, the nation’s first privately owned lender, climbed 1.7 percent to HK$9.06 at the midday trading break, and Bank of Communications Co., the fifth-largest, advanced 0.9 percent.
The central bank in June 2012 began allowing lenders to offer deposit rates capped at 110 percent of benchmark rates. The regulator left the ceiling intact this year even as it removed the floor on lending costs, saying that changes to rules for rates paid to savers were the “most risky” part of liberalization.
China’s benchmark one-year deposit rate stands at 3 percent, according to the PBOC’s website. That makes saving unattractive in a nation where the inflation target was set by the government earlier this year at 3.5 percent.
Total bank deposits shrank 0.4 percent from the previous month to 102.7 trillion yuan in October, the biggest decline since July 2012, according to the National Bureau of Statistics.
“NCD provides banks with a more stable financing tool than the time deposits,” Lu Zhengwei, a Shanghai-based economist at Industrial Bank, wrote in a note yesterday. “The biggest challenge of interest rate deregulation to banks is the continuous drain of deposits.”
Banks have already turned to off-balance-sheet wealth- management products, savings vehicles with higher yields, to retain savers. The amount of such investments surged ninefold from 2009 to 9 trillion yuan as of June, according to the China Banking Regulatory Commission.
NCDs can be bought by interbank market participants including banks, insurers and brokerages, as well as fund management firms. While individuals and corporates are excluded from the market, they can indirectly get access through mutual funds, according to Bank of America Corp.
That investment opportunity makes China’s savers the “unquestionable winners” from the introduction of NCDs, while non-financial corporates will also benefit because a majority of their funds at banks are in low-return demand deposits, Bank of America’s Hong Kong-based economist Lu Ting wrote in a note today. The higher interest banks pay on NCDs rather than deposits will squeeze their lending margins, he said.
The PBOC didn’t explicitly say when trading of the certificates would begin.
When China completes deregulation of interest rates, the Shanghai Interbank Offered Rate or the 7-day repo rate can become the new benchmark, Central Bank Deputy Governor Yi Gang said, according to a Nov. 26 report by the official Xinhua News Agency. He urged banks to get accustomed to using that as the basis for pricing financial products, Xinhua reported.
“The banks have underestimated the PBOC’s determination to accelerate interest-rate reform, and with the new rules on CDs they’ll be forced to take it seriously,” Zhou Hao, a Shanghai- based economist with ANZ, said by telephone. “The CDs give banks more flexibility in their funding, but the more profound impact will be on their borrowing costs as they move toward market-based interest rates.”
The rules allow fixed-rate certificates with maturities of one month to one year and floating-rate CDs for one, two or three years. Issuers are prohibited from buying their own NCDs and must disclose their annual sales plan at the time of the first sale.
“This is a crucial step toward full interest-rate deregulation,” said Liu Jun, a Wuhan-based analyst at Changjiang Securities Co. “There have been different opinions about the reference rate. While Shibor isn’t perfect, the mechanism can be improved as we move forward.”
The next step in interest-rate deregulation would be extending the CD market to corporate and individual investors, and liberalizing rates for deposits with maturities of five years and longer, Zhang Zhiwei, an economist at Nomura International Hong Kong Ltd., wrote in a note today.
Under separate guidelines published Dec. 2, the central bank plans a pilot program in the Shanghai free-trade zone to allow qualified financial institutions to issue large- denomination, tradable certificate of deposits as part of efforts to liberalize interest rates.
--Jun Luo and Aipeng Soo, with assistance from Alfred Cang in Shanghai and Penny Peng in Beijing. Editors: Nathaniel Espino, Russell Ward