BEIJING (Nov 26): After subsidizing banks and industry for decades, China's savers awoke Saturday to a surprise.

On the central government’s website a graphic explained that an interest-rate cut taking effect that day would protect returns on savings deposits while slicing at least 0.15 percentage point off lending margins.

The government site has since posted four news articles referencing the switch.

“This asymmetric interest rate cut makes the banks pass on their profits to benefit enterprises and savers,” said a Xinhua commentary accompanying the graphic.

“This is the central government’s shot in the arm for healthy development of the financial market.”

Payments to depositors that often failed to match the inflation rate enabled banks to funnel cheap loans to state enterprises and infrastructure investment, helping fuel three decades of 10 percent annual average economic growth.

A sustained easing of this so-called financial repression would channel more wealth to the masses and help boost consumption.

“China has started to undo decades of financial repression,” said David Dollar, a former US Treasury Department official in China who is now a senior fellow at the Brookings Institution in Washington.

“Chinese savers can get up to 3.3 percent on a one-year deposit. With inflation of 1.6 percent, that is a high real-interest rate compared to other major economies.”

A 0.4 percentage point cut in the one-year lending rate announced Nov 21 was accompanied by a 0.25 percentage point lowering of the one-year deposit rate.

In addition, the cap on what banks can pay customers on deposits was raised to 120 percent of the benchmark from 110 percent, leaving savers with unchanged returns at banks that raise rates to the new ceiling.

Unhappy banks
With the interest paid on demand deposits left unchanged, the increase in the cap means banks could increase returns on those funds by about four basis points.

Demand deposits accounted for about 36 percent of the nation’s 49 trillion yuan (US$8 trillion) of household savings at the end of October.

The People’s Bank of China’s rate cuts will slash banks’ margins by the most in a decade, wrote Hongyuan Securities Co. analysts Sun Hailin and Zhu Xiaoming in a Nov 25 note.

“The government’s protection of the interest-rate spread enabled banks to make enormous profits by just expanding their balance sheets,” the analysts wrote. “It’s a real act of reform.”

An article from China Business News posted on the government’s website this week said banks don’t like the asymmetric rate cut because it squeezes their profits.

Financial repression
“Banks helping to relieve the pressure is a sign of them carrying social responsibilities,” said the article.

“Banks have had a higher margin than the real economy for a long time.”

Financial repression, a concept detailed in 1973 by Stanford University economists Ronald McKinnon and Edward Shaw, refers to policies that result in savers earning returns below the rate of inflation, enabling banks to provide cheap loans to companies and governments, reducing the burden of repayments.

Low returns on savings and the cheap loans that result are among causes behind China’s reliance on investment for growth.

Financial repression also helped fuel an expansion in debt to levels evoking comparisons with the excesses that generated Japan's lost decade and the Asian financial crisis.

The low returns on savings also damps consumption.

Household spending accounts for a smaller share of gross domestic product in China than in any other major economy, according to Capital Economics.

Profits crimped
The rate cut wasn’t all bad for banks, said Wang Tao, chief China economist at UBS in Hong Kong.

“Even though their profit will be narrowed because of this cut in rates, it also reduces the financial risk for banks by lowering financing costs,” she said.

That improves companies’ repayment ability and will slow the formation of bad loans, she said.

Enabling banks to maintain deposit rates at previous levels also helps them retain funds amid competition from wealth management products and money-market funds.

Five of 16 listed Chinese banks raised their one-year deposit rates to the ceiling of the regulatory benchmark.

This isn’t the first time the lending rate was cut more than the deposit rate.

In July 2012, the PBOC lowered the one-year deposit rate by 0.25 percentage point and the one-year lending rate by 0.31 percentage point, while in September 2008 it cut the lending rate without lowering the rate for savers.

China is transitioning from a system of state-directed credit to one where markets play what Communist Party leaders term a “decisive” role in pricing capital.

A floor was removed from lending rates in July 2013 and PBOC Governor Zhou Xiaochuan said in March that deposit rates will be liberalized in one to two years.

“The days when banks could make easy money vacuuming up cheap savings and lending it on to government-backed borrowers are one step closer to their end,” said David Loevinger, former US Treasury Department senior coordinator for China affairs and now an analyst at TCW Group.