The December spike in China’s interbank interest rates, following a similar episode in June, reinforces two widely shared perceptions. The first is that dealing with the current debt overhang will exacerbate volatility; the second is that interest rates are too low. That financial reforms are needed, despite the risks, is beyond dispute. But whether interest rates — specifically deposit rates paid to savers — are actually too low, as many China-watchers have argued, is debatable.
The spikes in interbank rates stem in part from a bifurcated access to household savings deposits. The leading state commercial banks have a large deposit base to tap for lending; while many of the smaller private banks rely on the interbank market, a more costly and less reliable source of funds. The interbank market also serves a melange of bank and non-bank intermediaries engaged in “shadow banking” activities targeted to the private sector for higher, albeit riskier, returns.
Attempts by the central bank to moderate the debt build-up by tightening liquidity in the interbank market contributed to the rate spikes. But policy makers have also have a justifiable desire to encourage more support for the private sector by liberalising lending practices.