Nation preparing to remove deposit rate controls

China will allow financial institutions to issue certificates of deposits and will set up a guidance system before removing controls on deposit rates as part of reform efforts to promote a market-based interest rate regime, the vice governor of the central bank said Wednesday.

Liberalized interest rates are part of the reform road map of the world's second-largest economy and are expected to reduce the financial burden on cash-starved small firms as well as increasing deposit income for households.

The People's Bank of China (PBC). the central bank, will allow financial institutions to offer large-denomination certificates of deposits (CDs). and it will also set up a target rate system, Hu Xiaolian, vice governor of the PBC, said at a forum on Wednesday.

"When conditions are ripe, the PBC will remove controls on deposit rates, the final step toward a market-driven interest rate regime," she said.

A large-denomination negotiable CD allows depositors to negotiate for a preferential deposit rate, which can serve as a precursor to a market-driven rate, Liu Ligang, chief economist at ANZ Banking Group, told the Global Times Wednesday.

The PBC also needs to set up a target rate system, similar to the US Federal Reserve's funds rate, which serves to influence rates in the market, Liu said, noting that "without it, the central bank will lose control of its monetary policy."

A key requirement before a market-driven rate system can be introduced is a deposit insurance mechanism, Zhang Taowei, a finance professor at Tsinghua University, told the Global Times on Wednesday. Such a mechanism is needed to protect depositors against losses if a bank closes.

The State Council is working on regulations for a deposit insurance scheme, and could release it as early as the end of this year at the earliest, the Economic Information newspaper reported Wednesday.

Zhang said the insurance coverage should be set higher to protect against possible losses for depositors, partly because the household savings rate in China is one of the world's highest.

Due to a narrowing interest margin, banks will lend to projects with higher risks in order to earn greater returns, he said, noting that careful supervision will also be needed.