By Gordon G. Chang, Contributor  On Friday, the People’s Bank of China announced it was eliminating the floor on lending rates.  Prior to the change, which was effective yesterday, banks could not charge less than 30% of the benchmark rate set by the PBOC, the nation’s central bank.  Reaction to the move has been—with justification—overwhelmingly positive. “Previously, people had thought the central bank would only gradually lower the floor on lending rates,” said Wang Jun of the China Centre for International Economic Exchanges to Reuters.  “Now they scrapped the floor once and for all.” Mark Williams of Capital Economics, calls the change “one of the biggest steps they could have taken.”  Williams is correct, but only in a symbolic sense.  In the first quarter of this year, only around 11% of loans were made below the benchmark rate.  Today, that number is much smaller.  Liquidity remains tight after the two spikes in interest rates last month, and in recent weeks no lender was providing funding at rates near the floor.  In short, this reform will have no practical effect on the cost of money in China in the near term. Nonetheless, this change, as analysts uniformly tell us, sends a signal about the plans of Premier Li Keqiang, the country’s new economic czar.  But what is that signal? Most analysts think the PBOC’s announcement signals a quick removal of the cap on rates paid by banks to depositors.  Banks now may not pay more than 10% above the benchmark rate of 3%.  Abolishing the deposit ceiling would be in line with a widely praised promise Li’s State Council made in March. Most observers expect a change soon.  Everyone, therefore, is waiting for the Communist Party’s Third Plenum, a meeting typically held in the fall of the first year after a Congress meets (the last Party Congress met in November).  The Party’s new leadership has traditionally unveiled economic blueprints at Third Plenums, so many anticipate the announcement of reforms in a few months.  Despite the near-universal optimism, there are three principal reasons why we probably will not see a liberalization of deposit rates this year—or maybe even in 2014.  First, state banks have enjoyed cheap funding due to the deposit ceiling and will fight any change that will squeeze their fat interest margins.  Premier Li comes into this fight at a disadvantage.  He is the only known reformer on the Politburo Standing Committee, the apex of political power in China.  “Conservatives,” who represent entrenched interests, hold at least four—and maybe five—of the seven seats on that all-powerful body.  They will undoubtedly block elimination or significant relaxation of the deposit-rate ceiling. Second, it will soon become obvious that this is the wrong time to remove the rate cap.   The liquidity crises of last month caused two waves of bank defaults and almost brought down China’s largest bank, the Industrial and Commercial Bank of China.  ICBC, as the behemoth is known, shut down a part of its ATM system last month to conserve cash, and it reportedly received …read more

Source: FULL ARTICLE at Forbes Latest