Interest rate, ownership reforms go hand-in-hand

Banking shake-ups complement entry of private groups into industry

On July 23, Chinese Premier Li Keqiang reportedly chaired a State Council executive meeting, the purpose of which was to promote measures that could ease financial pressures facing small and medium-sized enterprises (SMEs). Specifically, meeting participants are said to have called for market-oriented interest rate reforms and the establishment of more private banks. Two days later, the China Banking Regulatory Commission (CBRC) announced that it had approved proposals from three private groups to establish banking institutions, two of which will primarily serve small-scale businesses and individual consumers.

Those advocating for China's SMEs have long called for interest rate reforms, controls on capital movements into banks and market-based allocation of resources. Building on reforms from the past, over recent months we've seen the government quicken its pace in terms of achieving these goals.

In 1993, the State Council unveiled "The Decision on Reform of the Financial System," a document which laid out the central government's long-term interest rate reform goals. Over the following years, the interest rate reform process drew ever larger amounts of private capital into the banking industry.

According to CBRC statistics, since 1996 - the year in which China's first private bank, China Minsheng Bank, was established amid joint-stock reforms aimed at other commercial banks - private funding has accounted for over 50 percent of overall capital at more than 100 small- and medium-sized lenders. Meanwhile, private money accounts for 90 percent of capital at many of the country's rural banking institutions.

But at China's biggest banks, State-owned capital controls the commanding heights. Given the oversized foothold the four largest State-owned banks hold in the financial sector, private capital accounts for only 10 percent of overall banking industry capitalization. Obviously, this figure is not a product of market competition, but market access restrictions for private capital holders. As a result, banks with predominately private sponsors have historically been slow to develop.

Yet, last July, financial institutions in China gained full liberalization over their lending rates, marking a tremendous step forward for private groups operating in the credit market. Moreover, China's central bank has claimed that deposit rates will be marketized within the next two years. These breakthroughs, combined with the promulgation of new laws supporting qualified private groups to establish their own banking institutions, have led to a surge of investor interest in banking.

In January, the CBRC announced that China will set up three to five "pilot private banks." Now, with explicit backing from the country's top leaders, the CBRC last week approved the establishment of three private banks. From the progression of recent events, it seems that market-oriented rate reforms and increased acceptance of private capital into the banking sector have gone, and will continue in tandem.

Similar connections can be seen in other countries - including South Korea, Russia, Hungary and Poland - with financial management policies and regulations that resemble those found in China. Historically, private capital often flows into the banking sector after interest rates are put under the sway of market forces. If we assume that deposit rates are on a path toward full marketization within two years' time, privately funded banks will surely rise to the opportunities that lie ahead.