Tired of being told something important is happening in China? Then stop and read something else.
No, this is not about stocks – that is tired. Beijing took a monetary policy step Tuesday, loosening interest rates and required reserve ratios and allowing banks to freely set (in principle) one-year deposit yields. When stocks calm, this liberalization will be hailed as important. It isn’t. Chinese interest rates can’t be free or anywhere close to it while state banks remain predominant.
A man walks past an electronic board showing the benchmark Shanghai and Shenzhen stock indices, on a pedestrian overpass at the Pudong financial district in Shanghai, China, June 26, 2015. REUTERS/Aly Song.
China has been in the process of formally liberalizing interest rates. First they were fixed by the People’s Bank. Then they were set by the central bank with a band for other banks to move rates, and now they are largely unrestricted by regulations. In this sense, Chinese finance is becoming more responsive to supply and demand and thus less wasteful.
But only a bit less wasteful. Over 90% of national banking assets are state-owned in one form or another. One problem, true for all state-owned enterprises, is how hard it is to imagine Chinese state banks engaged in purely commercial competition.
They are all subsidiaries of the same entity and — even more important — state banks cannot go bankrupt. They can be merged at the behest of the Communist Party but one state bank cannot aspire to price another out of business by being more efficient. A major reason to change deposit yields and loan costs is not in play.
Chinese state banks are actually in a worse position than other state-owned enterprises. Consider 2009: during the global downturn, Chinese state banks were ordered to lend far more. As profit opportunities vanished, bank lending soared 32% on orders from on high. This effectively ruined 10 years of gradual financial reform.
State banks are indispensable fiscal tools for the government. Market interest rates remain something merely to aspire to when politically acceptable.
The key is not “liberalization” of interest rates, but privatization of institutions. This has already occurred to some extent with the increased size of informal (shadow) finance. However, much of this money was offloaded from state bank balance sheets and most of it is badly regulated. What China needs is private, truly commercial, transparently operating banks.
An important step has been taken in that direction with a handful of licenses granted to private non-financials to open banks. But bank expansion takes many years. Just granting private licenses, without selling off state bank assets, will leave state banks dominating the system and interest rate liberalization a façade for at least a decade.
To some extent, interest rate reform is a microcosm of the entire effort. Beijing tries to step away from constant currency intervention, but steps back two days later. Unified property registration, which could be close to done right now, will not occur until 2020. And more. The reform journey is a long one and China has chosen a snail’s pace, even in banking.
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