In Depth: Battle for China’s Deposits Pits Banks Against Regulators

Chinese banks are grappling with a policy tug-of-war between raising interest rates to attract deposits and regulatory directives aimed at cutting rates to encourage spending and investment. Presently, regulators appear to be gaining the upper hand [para. 1].

Financial institutions have been urged by the government to expand credit to support the sluggish economy. Until recently, banks were incentivized to inflate lending and deposits as these metrics contributed to local GDP. However, changes by the national statistics bureau and the central bank in the first quarter of this year aimed to correct distortions in these figures [para. 2].

The struggling economy and poor outlook have reduced businesses' inclination to borrow. Consequently, savings have moved towards wealth management products and bonds offering higher returns, compelling banks to adopt innovative tactics to grow lending and deposits [para. 3]. Some banks have resorted to allowing companies to deposit their loans at interest rates higher than the borrowing costs, effectively pocketing the differential. Other banks engaged in illicit practices like offering preferential rates or manually adding interest at maturity [para. 4].

Regulators are cracking down on such practices over concerns that they artificially boost credit and deposit demand without truly benefiting the economy, leaving substantial funds idle within the financial system [para. 5]. This scramble for deposits also squeezed banks' net interest margin (NIM), a key profitability metric, which fell to 1.54% in the first quarter from 1.69% last year, its lowest in 13 years and below the warning threshold of 1.8% [para. 6].

In April, the People's Bank of China (PBOC) issued its first formal directive through the Self-Regulatory Pricing Mechanism since its establishment in 2013, signifying central government backing. The directive mandated banks to cease circumventions of deposit interest rate ceilings and conduct internal inspections to align with the rules by the end of April [para. 7][para. 10][para. 11]. The mechanism convened meetings with various banks, including national state-owned, joint-stock, and city commercial banks, to discuss this directive [para. 12].

Sources reveal that the directive aimed not only to prevent disorderly competition but also to curb "idle funds," which refer to money circulating within the financial system rather than the real economy [para. 13]. Zou Lan, PBOC's Monetary Policy Director, emphasized enhanced monitoring of these idle funds and expressed optimism that the issue would ease as economic transitions progress [para. 14].

China’s national state-owned and joint-stock banks have implemented multiple deposit interest rate cuts since September 2022. By April 2024, the average rates on demand and fixed-term deposits had fallen, reflecting ongoing policy efforts to boost the economy [para. 15]. Despite these efforts, large institutional clients maintain higher bargaining power, often negotiating higher interest rates, undermining official cuts [para. 16].

Around 10% of deposits in China’s listed banks involve manually added interest payments, amounting to roughly 20 trillion yuan ($2.8 trillion) [para. 17]. The practice of increasing savings rates indicates growing risk-aversion among banks, focusing on attracting high-quality clients deemed low-risk [para. 19]. However, such practices contribute to disorderly competition, challenging the banking sector's development and support for the real economy [para. 20].

Regulators' inspections revealed some companies’ practices of taking out large loans to invest in higher-yield products like certificates of deposit and wealth management products [para. 21]. Despite regulatory efforts, the continuation of such practices could perpetuate the current trend of weak economic sentiment, reducing business and household investment and consumption [para. 23].

While some smaller banks plan to circumvent tightened regulations by launching new products or advising clients towards alternative investments, the regulatory crackdown seeks to prevent such disorderly competition and ensure funds are channeled into the real economy [para. 25][para. 27].