Policy Forum 9 (September 2019)

It is generally believed China's financial reform lags behind its economic development. The market-oriented reform of interest rates began in the late 1990s, twenty years after 1978, when the policy of reform and opening up was initially put forward. During that time, the financial system was dominated by the banking sector, a subsidized credit system which channeled household savings at low interest rates into state-guided borrowing for investment (this situation hasn’t changed much until today, unfortunately). Non-banking financial sector was negligible; state-owned enterprises have the priority to cheap credit supplied by banks, which are crucial for their survival. The People's Bank of China (PBoC) set the same retail interest rates for all commercial banks and set different lending quotas for each bank. The government took a cautious attitude toward the reform of interest rate liberalization, at least partly because in the absence of deposit insurance, intense competition among banks may lead to instability of the banking system, and hence negative impacts on the real economy.

Financial reform accelerated during the past few years. In July 2013, the PBoC abolished the control of lending rates, and in October 2015, removed the ceiling of deposit rates. However, these measures do not indicate that interest rates are fully market-determined, as acclaimed by the media at that time. Official restrictions were cancelled, but only to be replaced by hidden controls. An industry self-disciplinary mechanism of market interest rate pricing, established in September 2013 and intended to avoid disorderly competition among commercial banks, imposed de facto restrictions on nominal interest rates. Commercial banks did not get full pricing power for their funds; the central bank continues to intervene in credit allocation and issue benchmark interest rates. And the financial market is still divided, characterized as a dual-track interest-rate system: on the one hand, retail interest rates of saving deposits and loans are administratively controlled; on the other hand, most asset prices in currency, bond and stock markets—including the interest rates of interbank markets—have been liberalized. This is why the dual-track interest rate reform was launched in 2018, a new round of market-oriented reform of interest rates which aims to integrate the two tracks of interest rates: regulated and market-determined interest rates.

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