Why analyst calls for more interest rate reform in mainland China

It'll teach lenders learn how to better price risk.

According to a report by Hang Seng Bank Limited, the removal of the floor on lending rates is a clear sign of the determination of the Central Government to implement further reforms. 

Many also view this as a prelude to lifting the cap on deposit rates, although such a step is unlikely to be taken in the near term due to its potential impact on the Mainland’s commercial banks.

The timing of the next move is uncertain, but interest rate liberalisation will no doubt continue, as it will lead to the more efficient allocation of capital and help drive the country’s economic restructuring, which is critical for the Mainland’s long-term growth and development.

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Better pricing of capital and risk

Interest rate deregulation will help lenders learn how to better price risk, leading to the more efficient use of capital. In the past, Mainland banks tended to lend mostly to stateoowned enterprises (SOEs) instead of taking on more credit risk to support private small and medium-sized enterprises (SMEs), as they could not charge variable rates.

This sometimes resulted in problems of inefficient fixed-asset investment or excessive capacity in some sectors and lack of funding in others. SMEs had to raise funding from sources other than banks, leading to a rise in the grey market (shadow banking), which falls outside the control of regulators.

This situation is likely to change after full interest rate deregulation. Banks will have to compete and those that survive will necessarily become more efficient, which will help put them on a more equal footing with global players.