Assessing the implication of China’s new LDR cap
China will remove the loan to deposit ratio (LDR) for commercial banks, which currently stands at 75%. LDR will be replaced by other liquidity monitoring measures.
LDR averaged 67.8% as of May but it’s likely not a true reflection of bank’s liquidity conditions as banks tend to reduce loans and hoard deposits towards month end when LDR is measured. Also, banks are facing difficulty attracting deposits as other forms of savings (e.g. wealth management products, equity market) emerge and the smaller and medium sized firms aren’t getting funding.
It should be implemented in 2-3 months, which means for June and July; we will still have the seasonal month end rise in rates. The State Council (cabinet) has submitted the removal proposal, which is part of the Commercial Banks’ Law. The Standing committee of the National People’s Congress (legislature) will approve this. Implementation in the coming weeks is unlikely since the Standing Committee is currently meeting and it is not on the agenda. The earliest passage will be in the next meeting in late August. The committee meets every other month.
Three main implications
First, it will encourage banks to give more loans and support growth. Property and banks are the likely winners since banks can extend more loans, especially mortgage loans. Also, the smaller banks should benefit more since they have high LDR because they have harder time attracting deposits (i.e. bigger is considered safer).
Second, it will smooth the interest rate curve and prevent the volatile, seasonal liquidity crunch (month end, quarter end). Smoother rates and less liquidity crunch will also support the equity market.
Third, we will still need an interest rate or reserve requirement ratio cut short term to cushion the growth slowdown and allow maturing debt to be rolled over smoothly. Markets will continue to be disappointed on Mondays if cuts are not delivered over the weekends when China changes policy.
Overall, this is inline and one of many steps China is undertaking in liberalising the financial market.
Background and context
LDR is used to assess bank’s liquidity. If a customer withdraws from a bank deposit but the bank has lent everything long term, it will have problems meeting the withdraw request. LDR measures this ability to meet liquidity needs.
China’s LDR is low internationally because of its large deposit base. Households and corporates are limited on where to park their savings and deposits are one of the limited choices. Financial market liberalisation and increasing the size of domestic equity/bond markets, opening the capital account to access international financial markets are solutions to give domestics more choices away from banks. Less reliance on LDR fits in president Xi’s goal to have markets play a bigger role in resource allocation. Banks will rely on markets based interest rates to guide how much loans and deposits to hold instead of one size fits all LDR ratios. This should foster more competition in the banking industry as well. Instead of LDR, China will likely move to international Basel standards of liquidity coverage ratio (ratio of highly liquid assets, cash, T-bills, to liquidity needs for 30 days).
Sean Yakota is head of Asia Strategy at SEB