The China Banking Regulatory Commission issued a notice on Friday saying “a minority” of banks had resorted to such tactics since the start of this year to attract deposits from clients. It said banks and individuals involved would be strictly punished.
China’s central bank sets a ceiling on the interest rate that Chinese lenders can offer depositors, as well as a floor on rates that they can charge borrowers, a practice that avoids cut-throat competition among banks and guarantees them a healthy lending margin.
But even some senior Chinese bankers have attacked the perverse incentives this strict control creates.
The chairman of Bank of China published an article in which he fretted about the unsustainable nature of a system that encourages banks to lend as much as they can in order to maximise profits.
The CBRC said on Friday that some banks have been illegally offering higher deposit rates to customers than allowed under regulations, while others have found more creative ways to entice deposits.
Other incentives for depositors included prizes and shopping cards and some banks were illegally paying fees to agents and middlemen to attract deposits.
Chinese banks last year extended roughly double the number of new loans handed out in 2008. Analysts have repeatedly warned that they will face a wave of bad loans and other difficulties as a result.
They said banks’ use of illegal incentives to entice depositors was a reminder of the limits of Beijing’s control over the vast branch networks banks have across the country.
Those Americans old enough to remember banking in the days before the passage in 1980 of Depository Institutions Deregulation and Monetary Control Act (DIDMCA) will know exactly what the Financial Times is talking about. Before 1980 the Federal Reserve Bank set the maximum interest rate US banks could pay on deposits (the once-famous Regulation Q).
For a variety of reasons during the inflation of the 1970s the deposit rate became too low and created a series of widening distortions in the capital allocation process. Among other things American banks, in order to compete for deposits but unable to do so by offering higher interest rates, resorted to a wide variety of non-monetary incentives – most famously offering toaster-ovens as gifts to anyone who opened an account. Depending on the size of your account you could also get free holiday packages, bicycles, and tons of other things – anything but money.
Chinese banks seem to be doing the same thing. Prevented legally from offering higher deposit rates, they are trying to increase their deposit base by providing either non-interest compensation (gifts) or they are illegally offering to pay higher rates.
Why should banks want to pay more for deposits? Because banking in China is a money-making machine that basically transfers income from depositors and tax payers to bank shareholders. The mandated difference between the maximum deposit rate and the minimum lending rate is so wide that banks make a huge profit on the spread as long as they don’t make risky lending decisions, and the way to avoid risky lending, of course, is simply to lend to SOEs [state-owned enterprises] and local governments (both of which are implicitly guaranteed ultimately by the household sector, via cheap deposits and taxes). This is the main reason why inefficient SOEs are flooded with cheap credit and the very efficient small and medium enterprises are starved of capital.
I have argued many times that a very large portion of new lending has gone into toxic investment – in excessive infrastructure, excess capacity, in real estate development – that is only viable by virtue of the implicit debt forgiveness that automatically accompanies artificially low interest rates.