Interest Rate Liberalization in China.docx
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Interest Rate Liberalization in China.docx
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InterestRateLiberalizationinChina
InterestRateLiberalizationinChina
TarhanFeyzioğlu,NathanPorter,and
ElődTakáts
IMFWorkingPaper
AsiaandPacificDepartment
InterestRateLiberalizationinChina
PreparedbyTarhanFeyzioğlu,NathanPorter,andElődTakáts
*
AuthorizedfordistributionbyNigelChalk
2009
Abstract
ThisWorkingPapershouldnotbereportedasrepresentingtheviewsoftheIMF.
TheviewsexpressedinthisWorkingPaperarethoseoftheauthorsanddonotnecessarilyrepresentthose
oftheIMForIMFpolicy.WorkingPapersdescriberesearchinprogressbytheauthorsandarepublished
toelicitcommentsandtofurtherdebate.
WhatmightinterestrateliberalizationdotointermediationandthecostofcapitalinChina?
China’smostbindinginterestratecontrolisaceilingonthedepositrate,althoughlendingrates
arealsoregulated.Throughcasestudiesandmodel-basedsimulations,wefindthat
liberalizationwilllikelyresultinhigherinterestrates,discouragemarginalinvestment,improve
theeffectivenessofintermediationandmonetarytransmission,andenhancethefinancialaccess
ofunderservedsectors.Thiscanoccurwithoutanymajordisruption.Internationalexperience
suggests,however,thatachievingthesebenefitswithoutunnecessaryinstability,requires
vigilantsupervision,governance,andmonetarypolicy,andaflexiblepolicytoolkit.
JELClassificationNumbers:
D43,E43,E58,G14,G18
Keywords:
Financialliberalization,financialderegulation,interestrateliberalization,China
I.INTRODUCTION
Financialliberalizationcanprovidemanybenefits.Byallowingforthebetterpricingof
capitalandrisk,liberalizationimprovestheallocationandefficiencyofinvestment(Abiad,
Oomes,andUeda,2004).Alargershareofintermediationwouldbeundertakenbymore
efficientbanksandthosebetteratassessingrisk.Morecreditwouldalsoflowtosectors
previouslyunderserved.Therangeoffinancialproductsshouldalsoexpand,allowingfirms
andhouseholdstobettermanagerisk,andprovidingthemwithportfoliodiversification
opportunities.However,ifattemptedprematurely,financialliberalizationmayalsoexpose
weaknessesinthefinancialsector,inhibitingintermediationandcreatingeconomicvolatility.
Inthispaperweaskwhatimpactinterestrateliberalization,acentralpartofanybroader
financialliberalization,willlikelyhaveonChina’sbankingsystem.
Chinahasalreadymadesubstantialprogressinliberalizingitsfinancialmarkets,andits
interestratesinparticular.Afteryearsofreform,however,therestillremainsaflooronbank
lendingratesandaceilingondepositrates.Thedepositrateceiling,inparticular,appearsto
bind,asdepositrateshaveremainedclusteredattheirbenchmark,andrealdepositrateshave
onaveragebeenzero.
InterestratecontrolsperpetuateimportantdistortionsintheChineseeconomy.First,
householdsarenotappropriatelycompensatedfortheirsavings,andtheirfinancialincomeas
shareoftotalincomeremainsoneofthelowestintheworld.Second,thelarge
administrativelydeterminedinterestmarginprovideslittleincentiveforbankstobecome
moreefficientandimproveintermediationandriskpricing.Third,creditconstraintsputin
placetolimitcreditgrowth(sinceinterestratesdonotservethatfunction)createan
environmentwherebankschannelfundstolargeandwell-connectedenterprises,awayfrom
small-andmedium-sizedenterprisesandhouseholds.Andfourth,thelackofmarket-
determinedinterestratesrobsthePeople’sBankofChinaofcriticalinformationon
macroeconomicandliquidityconditions.
Weinvestigatethelikelyimpactofreformusingtwodifferentapproaches.First,wedevelop
andcalibrateanoligopolymodelofthebankingsystem(SectionII).Usingthismodel,we
studythelikelyimpactofinterestratederegulation(SectionIII).Similarmodelbased
approacheshavebeenappliedtothestudyofderegulationinothermarkets(seeBushnell,
Mansur,andSaravia,2004;andKopsangas-Savolainen,2003,forelectricityreform
examples).
Themodelsimulationsshowthatliberalizationresultsinahighercostofcapital,alower
volumeoflending,andmoreeffectivemonetarypolicytransmission.Allofthismayoccur
withoutharmingthesoundnessofthebankingsector,andindeedtheefficiencyofthesystem
asawholeisenhanced.Smallerbanks,inparticular,benefitfromliberalization.Byopening
afurtherchannelforcompetition,smallbanksareabletoattractadditionaldepositsand
expandtheiroperations.Largebanksscalebacktheirdepositbasesasfundingcostsrise.
Freerdepositratesalsoenhancetheimpactofagivenchangeintargetedinterbankrateson
depositandlendingrates,aswellasonintermediationactivity.Thebankingsystemremains
soundeveninthefaceofgreatercompetitionafterliberalization,despitesomewhatnarrower
deposit-loanratemargins.
Oursecondapproach—thediscussionofaseriesofcasestudies—askswhattheexperience
ofinterestrateliberalizationinothercountriesmayimplyforChina(SectionIV).The
experienceofotherreformershighlightanumberofpreconditionsforsuccessfulreform,
includingmacroeconomicstability,soundbankgovernanceandsupervision,andappropriate
monetarypolicyinthefaceofanyexcessivedemandafterreform.Liberalizationislikely
easiestwhenthecontrolsarerelativelylessbinding,andtheprivatesector’screditdemandis
unlikelytojumpafterreform.Thesepreconditionswouldseemtobebroadlyinplacein
China.Nonetheless,bothbankingsupervisionandmonetarypolicywillneedtoremain
vigilantparticularlyintheearlystagesfollowingliberalization.Followingthelossofdirect
controloverdeposit(andlending)rates,thePBCwillalsohavetorelymoreonindirect
monetarypolicytools.
II.AMODELOFCHINA’SBANKINGSECTOR
Inthissectionwedevelopamodeltocapturethemaincharacteristicsofthebankingsectorin
China.Themodelallowsforbankstohavedifferentsizes,acrossboththeirdepositsand
loans.Italsoallowsbankstooperatewithbothincreasinganddecreasingreturnstoscale,
andhavedifferentlevelsofprofitability.Theseassumptionsareconsistentwithbankshaving
marketpowerdespitecompetingagainsteachother(afindingofFeyzioğlu,2009).
Specificallywemodelbanksasoligopolists,inthesensethateachbankchooseslendingand
deposittakingactivityinawayanalogoustoCournotcompetitioncommonlydescribedin
industrialorganization(seeFreixasandRochet,2008,forabroadertreatmentofbanking
sectormodels).
III.HOWMAYINTERESTRATELIBERALIZATIONCHANGECHINESEBANKING?
Withthecalibratedmodelcapturingthemainpatternsofintermediationandefficiencyin
Chinesebanking,wecannowapplythemodeltoinvestigatetheimpactofdepositrate
liberalization.Giventhattheimpactofinterestrateliberalizationmaydependoncentralbank
operations,weconsiderthreedifferentassumptions:
(i)thecentralbankoperatesmonetary
policybytargetingtheinterbank(IB)rate(holdingitconstant);(ii)thecentralbanktargetsa
spreadoverthenowendogenouslydetermineddepositrate;and(iii)thecentralbankis
relativelypassive,andallowstheinterbankratetoendogenouslycleartheinterbankmarket
giventhenewlendinganddepositrates.
Intherestofthesection,wedescribetheimpactofliberalizationgiventhesedifferent
assumptionsforcentralbankbehavior.Specifically,weaskfourquestions:
(1)Whatisthe
impactofliberalizationonintermediation?
(2)Doesthecentralbanks’operatingtarget
significantlyaffecttheimpactofreform?
(3)Whatimplicationsdoesliberalizationhavefor
theeffectivenessofmonetarypolicy?
(4)Howdoestheimpactofliberalizationdependon
theextentofcompetition?
A.TheImpactofLiberalization
IntermediationandBankingSystemSoundness
Liberalizingthedepositrateallowsbanksanadditionalchanneltocompetefordeposits,and
thereforefundtheirlendingoperations.Themodel-basedresults,asshownintheempirical
distributionsoncethedepositratecapiseliminated(Figure2),showsthatbankswouldlikely
takefulladvantageofthisadditionalchannel,withsmallerbanksofferinghigherdeposit
ratestoincreasetheirsize.Thelargerbanksshrinktheirdepositbasestoreducecostsasthe
depositrateincreases,althoughtheultimateextenttowhichdepositsshrinkislimitedbythe
needforliquiditytomeetreserverequirements.Asaresult,concentrationinthedeposit
marketfalls.Theimpactonthedistributionoflendingissmallerthanonthatofdepositsas
thelendingmarkethadalreadybeenlargelyliberalized,andthemigrationofdepositsaway
fromthelargestbankshasonlymodesteffectsonlendingsincethesebankswerehighly
liquidalready.Onaverage,profitability(asashareofloans)changeslittle(seeTable1),but
thatdisguiseslowerprofitsatlargebanksoffsettinghigherprofitsatsmallerones.Onnetthe
depositraterisessufficientlytobringadditionaldepositsintothesystem,andloanratesand
thecostofcapitalincreasetherebyreducingthevolumeoflendingundertaken.Althoughthe
shareofdepositsatbanksmakinglossesincreasesslightly(neverabove3¾percent),this
reflectsabankthathashighcalibratedfixedcostsbutrelativelylowmarginalcosts,asthe
numberoflossmakingbanksfalls.
Thesetrendsareconsistentacrosscentralbankoperatingprocedures(Table1).Theresulting
interestratesareve
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