Chinese Banks Heed PBOC Call, Cut Dollar Deposit Rates

Chinese commercial banks have responded to the People's Bank of China (PBOC) call to cut dollar deposit rates, according to sources familiar with the matter. This move, which aligns with the central bank's broader monetary policy framework, aims to create a sound financial environment for economic recovery. The reduction in deposit rates is expected to have both short-term and long-term impacts on banks' net interest margins, the flow of funds into the capital market, and the broader economy.

The PBOC has established a market-based adjustment mechanism that guides commercial banks to align their deposit rates with changes in the one-year LPR and the yield on 10-year Chinese government bonds. This mechanism has led banks to adjust their deposit rates in line with policy benchmarks, as seen in this instance. The recent deposit rate cuts by commercial banks follow the PBOC's interest rate cuts, including the reduction in the seven-day reverse repo rate and the medium-term lending facility rate. These cuts aim to ease commercial banks' funding costs and stabilize their net interest margins, which is crucial for maintaining the stability of the banking sector and supporting economic recovery.

The reduction in dollar deposit rates by Chinese banks is expected to have both short-term and long-term impacts on their net interest margins and profitability. In the short term, lower deposit rates mean banks pay less to attract deposits, reducing their funding costs. For instance, a manager at a Bank of China branch in Shanghai mentioned that the one-year dollar deposit rate dropped from 5% to 4.3% for deposits above $50,000, and 2.8% for those under $50,000 (Source: Global Times, August 20, 2024). This reduction in funding costs can help improve banks' profitability and their ability to serve the real economy.

However, in the long run, reduced deposit rates could lead to a decline in net interest margins if banks are unable to pass on the full extent of the rate cuts to their lending rates. This is because banks may face regulatory constraints or competition from other financial institutions, which could erode their profitability over time. For example, in 2015, significant policy rate cuts resulted in a 60 basis point narrowing of net interest margins for commercial banks (Source: China Finance 40 Forum, August 20, 2024).

The deposit rate cuts by Chinese commercial banks also have potential consequences for the flow of funds into the capital market and the broader economy. Lower deposit rates may encourage market entities to invest more in the capital market, as the returns on deposits become less attractive compared to other investment options. This can boost the flow of funds into the capital market and the real estate sector, which can contribute to the benign circulation of the economy. Additionally, lower deposit rates may encourage market entities to invest more in consumption, further stimulating aggregate demand and supporting economic recovery.

However, these moves also pose risks to the banking system, as they have historically eroded net interest margins for commercial banks in China. This trend raises questions about the sustainability of the banking system, which relies on the differential between what banks earn from loans and what they pay on deposits (Zhang Bin, China Finance 40 Forum). Policymakers must navigate this delicate balance to ensure the stability of the financial sector while supporting economic growth.

In conclusion, the decision by Chinese banks to cut dollar deposit rates aligns with the PBOC's broader monetary policy framework and its commitment to creating a sound financial environment for economic recovery. While this move has potential short-term benefits for banks' net interest margins and profitability, there are also long-term risks and broader economic implications that policymakers must consider. By encouraging investment in the capital market and consumption, deposit rate cuts can support economic recovery. However, these moves also pose risks to the banking system, and policymakers must ensure the stability of the financial sector while supporting economic growth.