December 13, 2013 / 8:32 AM / 4 years ago

China tests interest rate freedom

6 Min Read

* PBoC introduces negotiable CDs in step towards deregulation

* New security offers market-based gauge of funding costs

* Shibor link will help boost relevance of benchmark rate

By Carrie Hong

HONG KONG, Dec 13 (IFR) - China took another big step towards full interest rate liberalisation this week with the first issues of negotiable certificates of deposit.

As well as opening a new source of liquidity for banks, the creation of the new security will create the country's first transparent, market-based gauge of deposit rates, paving the way for the eventual removal of central bank controls.

Within five days of the People's Bank of China unveiling guidelines, 10 banks had sold Rmb34bn (US$5.6bn) of negotiable CDs in the interbank market, underlining the extent of demand for the product.

The structure is still being tested by the PBoC, though. Only the top 10 banks by total assets are eligible to issue negotiable CDs for now, and the bonds are only available to participants in the interbank market, not individuals or corporate investors.

Analysts expect the pilot scheme to grow as more investors are allowed to participate, lifting the use of market-determined rates and creating a transparent pricing benchmark.

"It is likely that the interbank negotiable CD is just the prelude for a broader negotiable CD that can be sold directly to corporates and individuals. Based on the US experience, we believe that in equilibrium, medium and small banks would rely much more on negotiable CDs as a funding source, with 24% of total deposits replaced by negotiable CDs, while negotiable CDs at large banks would account for only 9%," said May Yan, head of banks sector research for Asia ex-Japan at Barclays in a client note.

The PBOC dictates loan and deposit rates in China, but has been gradually introducing market-determined benchmarks as it works towards liberalising interest rates. It loosened controls for most loans in July and has introduced a market-set loan prime rate as an alternative to the central bank's own lending benchmark. Deposit rates are still subject to an upper limit.

Shibor Boost

The new product will also help boost confidence in the Shanghai interbank offered rate (Shibor) system. The PBoC has been trying to promote the Shibor as the benchmark for short-term borrowing costs, but traders said that they prefer taking short-term repos as trading references. Market participants complain that Shibor offers "no real traded prices especially in longer-tenor categories," with rates at six-months and beyond typically quoted far lower.

"If the negotiable CDs market can take over the [direct deposit] deals in the future, I think Shibor might regain its market recognition and be a real market-oriented benchmark as with Libor," said one senior bank trader, referring to the current situation by which banks offer term deposits to each other.

Before the launch of the negotiable CDs, China's banks resorted to making deposits with each other at pre-agreed prices that were not publicly disclosed or pegged to any benchmark. Those private interbank deposits cannot be publicly traded or used as collateral in the secondary, in contrast to the negotiable CDs.

Low Yields

One week into the official kick-off of the new security, it seems to be a hit already. The country's top five lenders brought the debut batch of Rmb19bn (US$3.13bn) of negotiable CDs on December 12 and other five comparatively smaller banks followed with a total of Rmb15bn the next day. All but one of this week's transactions offered yields below Shibor.

"With negotiable CDs, we can access to large amounts of funds at relatively stable costs from the market," said a banker. "It is a very efficient liquidity management tool for us."

Bankers also pointed out that the comparatively long tenors of negotiable CDs allow for better asset-liability matching and overall liquidity management. Once the structure is widely available to investors it will also provide an avenue to raise funds if direct interbank lending seizes up as it did on June 20, when short-term money market rates spiked to nearly 30%.

Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial and Commercial Bank of China offered template deals of Rmb3bn for three months, Rmb5bn for three months, Rmb5bn for three months and Rmb3bn for one month at yields between 5.064% and 5.1708%. Three-month Shibor is currently around 5.32%. The biggest policy bank, China Development Bank, priced a Rmb3bn six-month negotiable CD to yield around 5.30%, in line with the other lenders but higher than the 4.52% quote for six-month Shibor.

Market participants, however, were sceptical that the first negotiable CDs offer a good read on market appetite. "For the debut offerings, the banks are the main buyers of each other's deals, and that is why the yields are relatively low," said an asset manager from a securities house. "I also bought some but just as a favour to one of the banks."

Five more banks joined the issuing queue on Friday with deals totalling Rmb15bn (US$2.47bn). Bank of Communications, Shanghai Pudong Development Bank, China Industrial Bank, China Merchants Bank, and China Citic Bank, each offered negotiable CDs of Rmb3bn and all, with the exception of CIB, which issued at a tenor of one month, had maturities of three months.

All deals were issued on the China Foreign Exchange Trade System and settled in the Shanghai Clearing House. (Reporting By Carrie Hong; editing by Christopher Langner and Steve Garton)

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