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China Removes Cap on Forex Deposit Rates in Shanghai

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China expanded banks’ freedom to set
foreign-currency deposit rates in Shanghai, a step toward easing
interest-rate controls across the nation.

The People’s Bank of China said today it will remove the
ceiling on foreign-currency deposit rates across the city
effective tomorrow for what it described as small accounts. The
trial will start with institutional accounts and individual
accounts will be added later based on “market conditions,” it
said in a statement.

The PBOC abolished limits on foreign-currency interest
rates on March 1 for deposits of less than $3 million inside
Shanghai’s free-trade zone as part of plans to give markets a
greater role in setting prices. The central bank, which removed
the floor on most lending rates in July 2013, will liberalize
state-set deposit rates within one to two years, Governor Zhou Xiaochuan said in March.

“This is a small step in deposit-rate liberalization
because forex deposits are a tiny fraction of the total,” said
Dariusz Kowalczyk, senior economist at Credit Agricole SA in
Hong Kong. “However, the removal of forex deposit caps does
represent a step towards liberalization of interest rates and
will increase hopes for raising the cap on yuan deposits in
coming months. This in turn would lead to higher rates
throughout the economy.”

Banks Struggle

The PBOC set a ceiling of 3 percent on one-year U.S. dollar
deposit rates in May 2005, according to its website. Banks are
currently offering well below that level, with Industrial
Commercial Bank of China Ltd., the nation’s largest lender,
paying 0.8 percent and China Merchants Bank Co. paying 0.7
percent, according to their websites.

Interest-rate deregulation will add to pressure on China’s
biggest banks, whose shares are trading near record-low
valuations as they struggle with increasing non-performing loans
and weaker earnings growth. Banks’ net interest margin, a key
measure of lending profitability, fell to 2.58 percent as of
March from 2.68 percent in December, according to the China
Banking Regulatory Commission.

The central bank didn’t define the size of small accounts
in today’s statement. The PBOC will take measures if it sees
significant flows in deposits or large movements in interest
rates at certain banks, until temporarily suspending the
service, Zhang Xin, head of the PBOC’s Shanghai branch, said at
a press conference in the city today.

‘Spill-Over Effect’

China had $565.8 billion of foreign-currency deposits as of
May, equivalent to about 3 percent of the 109.8 trillion yuan
($17.6 trillion) in local-currency savings, according to central
bank data.

Foreign-currency deposits in Shanghai account for one-seventh of the national total, or $76.7 billion at the end of
May, of which 26.4 percent are deposited in small accounts,
according to Zhang.

Local banks have set up a committee to regulate activity
and prevent significant flows in deposits or large interest-rate
changes, Zhang said. Existing regulations place few restrictions
on customers opening accounts in different places, so money
transfers aimed at taking advantage of rate differentials within
a bank need to be properly controlled, Zhang said.

“There could be broad spillover effects,” he said. “We
hope the market will be basically stable: no abnormal or large
changes in interest rates, or large flows of deposits between
banks or across regions within the same bank.”

Complete Liberalization

The State Council, or cabinet, said after a meeting last
month that the government will cut funding costs and maintain
reasonable growth in credit as economists forecast the weakest
expansion in 24 years. The banking regulator on June 6 vowed to
expand loans to small businesses, infrastructure projects and
first-home buyers, and said it may ease the ratio of loans to
deposits by including some stable sources of deposits in the
calculation.

“We are just a few steps away from a complete interest-rate liberalization,” said Tang Yayun, a Shanghai-based analyst
at Northeast Securities Co. “But the process could be delayed
as the government battles against a slowing economy and rising
borrowing costs. Naturally the deregulation would lead to higher
deposit rates and eventually higher borrowing costs for
companies.”

To contact Bloomberg News staff for this story:
Helen Sun in Shanghai at
hsun30@bloomberg.net;
Jun Luo in Shanghai at
jluo6@bloomberg.net

To contact the editors responsible for this story:
Paul Panckhurst at
ppanckhurst@bloomberg.net;
Chitra Somayaji at
csomayaji@bloomberg.net
Nerys Avery, Scott Lanman

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