Schroders: The paradox of Chinese rate cuts

The cut was accompanied by a lift to the deposit rate ceiling, allowing banks to offer 1.3 times the benchmark, up from 1.2 times.

For deposit rates, the net effect is that the maximum deposit rate allowable falls from 3.3% to 3.25%. However, as analysts at Deutsche Bank have pointed out, not all banks are taking advantage of the added flexibility. Ahead of the announcement, the five big banks offered a deposit premium of just 8% over the benchmark (i.e. a deposit rate of 2.97%). It was chiefly the smaller banks who were competing aggressively for deposits, offering the full 20% premium (a deposit rate of 3.3%). This seems likely to persist, implying a greater margin squeeze for the smaller banks than for the big five.

On the lending side, existing loans are now easier for borrowers to service, which should help asset quality. Again though, we are unconvinced that this is all that helpful to banks. After all, lending rates are liberalised in China – if banks believed lower rates would be beneficial they are free to offer them. Instead, it looks like the PBoC forcing bank support for endangered corporates. But with periodic repricing of loans the relief will be short- lived; banks will likely have to charge higher rates on new lending if they want to maintain net interest margins.

Consequently, though we are open to persuasion on the topic, it is hard to see this as especially positive for growth. Rather, it reduces the risk of corporate defaults for a year or so, but will probably weigh on growth via more expensive credit after that point. China could be facing a similar faulty transmission mechanism problem to the one that the eurozone has had to deal with.