In recent financial news, significant adjustments are being made to the mechanism regulating non-banking deposit ratesThis initiative aims to streamline the management of interest rates in the financial sector, particularly in the realm of interbank deposits, which have faced various challenges in adapting to shifts in monetary policyThe introduction of self-regulatory measures surrounding deposit interest rates is expected to alleviate bottlenecks that have emerged during periods of declining ratesThe adjustments not only promise to enhance the efficacy of monetary policy in supporting the real economy but also intend to relieve financial institutions from the pressures of shrinking net interest margins.

On November 28, a meeting was held to discuss the workings of the market interest rate pricing self-regulatory mechanism, which is critical for maintaining competitive order in the financial markets

The guidelines that emerged from this meeting will take effect on December 1, marking a pivotal shift in how rates are monitored and adjusted between banks and other financial entities.

Two primary recommendations were put forthThe first recommendation revolves around standardizing the interest rates for non-banking interbank deposits, especially regarding both regular and term depositsThis new regulatory framework stipulates that interbank term deposit rates cannot exceed the excess reserve rate established by the central bankThe second recommendation addresses the need for transparency in deposit service agreements between banks and their corporate clients, ensuring timely reflection of any rate adjustments during the term of the agreementThis safeguard, termed the "interest rate adjustment peg," is designed to prevent discrepancies that could arise due to changes in broader interest rate policies.

The current interest rate environment encapsulates some significant disconnects in the transmission of monetary policy, particularly at the deposit level

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Recent trends indicate that while lending rates have decreased notably, the adjustments in deposit rates have lagged behindThis misalignment has resulted in a constriction of banks' net interest margins, threatening their financial health and, consequently, the effectiveness of monetary policy aimed at stimulating economic growth.

Addressing the Challenges of Deposit Rate Reductions

The evolution of interest rate mechanisms has led to a more market-oriented system in which the central bank influences short-term rates through policy shifts, significantly impacting money and bond marketsFor instance, when the central bank adjusts the seven-day reverse repurchase agreement rate, it influences the yields on interbank certificates and treasury securities, ultimately affecting the lending and deposit rates offered by banks to consumers and businesses.

Generally, the transmission of these policy rates is relatively efficient

However, variations exist across different sectorsFor example, money market and bond market rates tend to move in sync with the central bank's policy shifts, whereas deposit and loan rates can diverge considerablyOver a recent span from August 2019 to August 2024, the one-year loan prime rate (LPR) has decreased by about 0.9 percentage points, while average loan rates have dropped by around 1.9 percentage pointsIn stark contrast, the average rate on term deposits has only seen a decline of 0.5 percentage points since then.

The primary impediment to effective interest rate transmission lies within the deposit segment of the marketThe inability to adjust deposit rates in a timely manner, especially in a declining interest rate landscape, threatens to compress banks' profit margins significantly, which in turn undermines the effectiveness of monetary policy interventions.

One of the reasons behind this resistance to lowering deposit rates stems from what the central bank refers to as "scale psychology" among banks

Many institutions view deposits as foundational to their operationsConsequently, during performance evaluation periods—such as month-end or quarter-end—some banks engage in practices that inflate deposit rates, effectively paying higher interest to attract deposits, negating the intended effects of lower policy rates.

Moreover, a number of banks resort to discretionary interest supplementation—boosting rates on existing deposits despite official reductions—essentially resulting in what can be termed a façade of lower ratesSome institutions have even gone so far as to outbid one another for deposits by offering excessively high rates, elevating the average interest rates offered in the market.

In response to these issues, the central bank has implemented a variety of measures designed to clear these deposit-related bottlenecks

These measures include establishing a framework for price-setting in the deposit market, guiding proper pricing behavior among financial institutions, and introducing a deposit auction rate reporting mechanism to promote efficient allocation of financial resourcesAdditionally, regulations have been put in place to inhibit excessive discretionary interest payments, ultimately saving banks significant amounts in interest expenditures, exceeding 800 billion yuan.

The recently introduced pricing self-regulatory mechanism aims directly at addressing the aforementioned high-deposit rate issues while simultaneously facilitating the transmission of interest rates more effectively.

Mechanisms and Impacts

With regard to interbank deposits, non-bank institutions typically command a sizable amount of funding, granting them substantial bargaining leverage

During the years 2022 to 2024, the ongoing interbank deposit rates hovered around 1.75%, largely ignoring shifts in the central bank's policy ratesCertain financial service institutions were reported to offer rates nearing 3% at specific banks for their interbank demand deposits.

Analyses from Huayuan Securities suggest that under the newly introduced self-regulatory framework, non-bank entities will now reference the central bank's seven-day reverse repurchase operation rate to establish fair interest rates for their depositsThis regulatory oversight is intended to manage the upper limits on deposit rates, particularly for demand deposits whose terms are typically shorter than seven daysConsequently, it is projected that deposit rates in the non-banking sector will decline to 1.5% or even lowerThis regulatory mechanism will serve to significantly narrow any potential arbitrage opportunities between typical deposit rates and those of non-bank interbank deposits, thereby restoring the focus on the payment and settlement functions of such deposits.

Research from Zheshang Securities has highlighted that major listed banks represent a significant market for interbank demand deposits, estimated around 15 trillion yuan

A reduction of 20 to 30 basis points in interbank demand deposit rates is anticipated to improve the net interest margins for these banks by approximately 1.3 to 2.0 basis points.

Nevertheless, the impact of these initiatives will differ across banks due to the variations in their funding structuresOver recent years, growth in interbank deposits has primarily concentrated within the largest banksFrom January 2023 to the present, the interbank deposit holdings of the largest banks surged from 9.7 trillion to 17.1 trillion yuan, whereas smaller banks barely moved from their previous levels.

In the wake of these recommendations, if the major banks find themselves inadequately positioned to acquire sufficient interbank deposits in a short time frame, they may need to restructure their balance sheets more radically

This situation could lead them to seek alternative sources of funding—like interbank certificates—but these efforts may be restricted by set quotas and limits on interbank borrowing ratiosThe outcome could force these banks to contract their balance sheets, thereby diminishing their capacity to lend and possibly exacerbating declines in social financing.

Further measures by the central bank, such as adjustments to reserve requirements, likely remain crucial for resolving the funding challenges faced by these large banks.

But what exactly is the "interest rate adjustment peg" referred to in the regulatory proposals? Essentially, corporate clients will engage in frameworks with banks that encompass key deposit details, including interest rates, before formalizing any specific deposit contracts

During the duration of this overarching agreement, the stipulations surrounding interest rates remain fixed and unaltered by changes in posted rates or regulatory modificationsThe aim is to integrate "interest rate adjustment peg" provisions in these agreements to guarantee that any fluctuations in bank interest rates are promptly reflected in the actual deposit services provided to clients.

This long-term commitment to deposit rates poses challenges; on the one hand, it risks anchoring deposit rates when they should be more flexible, thus hindering effective monetary transmissionOn the other hand, such prolonged agreements create considerable interest rate risk for banks, which cannot easily hedge these exposures using existing interest rate derivates due to mismatched cyclical patterns.

Estimates indicate that banks typically categorize demand deposit repricing windows as occurring within one month, while term deposits follow their respective maturities