China – How to prevent a housing bubble
Written by Standard Chartered Global Research
Tuesday, 14 September 2010 14:17
Key points
* Wealth management products offer higher rates than standard fixed-term deposit rates
* But real negative rates mean these products do not prevent asset inflation pressure
* We expect house prices to rise more; without rate reform, nationwide housing bubble is likely
KUALA LUMPUR: There is more interest rate freedom in China than meets the eye – but not enough to stop an asset bubble forming, we believe. Real People’s Bank of China (PBoC) base rates are super-low for an economy growing at 8-10% in real terms.
The real 1Y PBoC deposit rate is currently at -1.25% (using current CPI inflation to adjust the nominal rate). In other words, depositing money at the bank costs you money. For corporates, borrowing is super-cheap, at 1% for a one-year loan (using producer price index, or PPI, inflation to deflate the nominal 5.31% rate).
As a result, while the central authorities may occasionally roll out higher down-payment requirements for home purchases or build more low cost housing, we expect a nationwide housing bubble to form in the next few years if interest rates are left where they are.
Officially, banks can offer loans at rates as much as 10% below the loan rate, and at any rate above it; on the deposit side, banks can offer lower rates than the base, but not higher.
However, there is a lot more to interest rates in China than the official rates. For instance, short-term draft financing (via instruments such as banker’s acceptance drafts) is done below the PBoC base loan rate. A reasonably sized corporate can currently obtain a three-month draft at 3.2-4.0%, versus the 4.9% base rate for a three- to six-month loan.
A big, cash-rich company can on lend to a cash-poor company, via a bank, through an entrustment loan structure, and negotiate its own rates – at present, a large multinational can lend to another large multinational, all onshore, at a rate of 3.0-3.5% for up to six months, or at 4.0-4.5% for up to one year, compared with official rates of 4.9% and 5.3%, respectively.
Non-bank financial institutions with large deposits (more than CNY 30mn) can negotiate a higher-than-benchmark rate with their banks – the rate as of end-June was around 4% for a deposit of more than five years (compared with the 3.60% PBoC base rate). And for wealthy retail depositors, China’s banks have offered a feast of wealth management products (WMPs) in recent years which offer higher returns on retail deposits for a bit of extra risk.
We recently reported on the informal banning of one type of WMP – those offered by trust companies via banks.
These products were the packaged results of corporate loans extended by banks or trust companies. As a result, they could offer relatively high interest rates (around 3% on a trust loan in March 2010).
With the removal of these products, what is a wealthy Shanghai depositor to do with all her cash? Are the banks still able to offer enough through other structures to keep real rates above zero?
What can you get for your deposit now?
We asked this question of several branches of shareholding and city commercial banks in Beijing and Shanghai last week.
Smaller shareholding banks are more in need of deposits, since they lack the branch networks of the biggest banks. We wanted to find out which rates and structured deposit products were on offer. We also looked into whether trust products have been taken off the market entirely.
Our key findings:
• Banks are not offering floating deposit rates (as has been suggested in various media reports). PBoC benchmark rates are applied to all fixed-term deposits.
• Only one bank offered anything close to a floating-rate deposit. This small bank, which opened its first branch in Shanghai recently, offers attractive rates on demand deposits, basically paying a fixed-term interest rate for the period the deposit is with them. (In contrast, if you put your money in a standard term account and withdraw it early, you are paid the on-demand interest rate of 0.36%.) This small bank currently offers a 1.19% 1M deposit rate, for example. The downside is that it only has one Shanghai branch so far, so access is limited.
• There is an array of WMPs on offer, some very short-term and low-risk. One salesperson even told us, “Fixed deposits are so out these days!” We found three basic types of WMPs during our visits to the banks:
1. PBoC bill-based products. These are issued each day, the total amount depending on the bank’s asset-liability ratio (or perhaps even the branch’s, given that Beijing and Shanghai branches of the same bank were offering different rates), and are issued on an ad-hoc basis. Products range from 7-day to 1Y, with annualised rates ranging from 2.3% to 3.45%.
2. ‘Residual’ trust products. Most banks warned us that the bank regulator is now prohibiting them from selling trust products (as we reported) and new, stricter regulations are now in place for high-risk wealth products. Most banks we visited were not offering trust loans. In Beijing, though, a couple of banks were still offering trust products which had been launched before the regulator stopped them.
And one bank in Shanghai was selling a bundled quasi-trust product which included a trust loan along with bills, bonds, and FX. This product ranged from 1M to 6M, with annualised rates of 2.5% to 3.2% – well below the rates offered on trust products before the ban in April.
3. Banks marketing others’ WMPs. One major commercial bank in Shanghai was marketing a high-yield WMPs on behalf of a relatively new insurance company. This is a 5Y product with a 12.5% total yield at maturity. It also comes with additional perks: five annual bonuses based on the insurance company’s performance (at least 1.3%, we were told) and an accident insurance policy offering five times the standard cover. One bank in Shanghai was offering a one-off bonus on top of returns for customers who bundle their deposits, equity and fund investments together and entrust them all to the bank’s partner securities broker.
On average, we found that one can expect to receive returns of around 2.6% on a 3M WMP deposit, or 2.9% for a 1Y WMP deposit, compared with the 1.71% and 2.25% PBoC fixed rates, respectively. In other words, although WMPs offer significantly higher rates than standard deposits, given that inflation is running at 3.5% y/y, these rates are still negative in real terms. (The trust companies are still able to market and sell trust products to their VIP clients; rates in July were reported to be around 8.5%.)
Banks’ policies on principal protection seem to vary. In Shanghai, several banks told us specifically that they were no longer able to offer 100% principal protection on WMPs (which suggests that they were previously allowed to). In practice, the bankers we spoke to offered a verbal promise of principal protection. However, in Beijing, a number of city commercial and large commercial banks that we visited still offer 100% principal protection in the contract, as long as the deposit reaches the maturity date.
Freeing up deposit rates is necessary to prevent a housing bubble
To conclude, while wealthy depositors have access to better rates on structured deposit WMPs, these rates are still not high enough to eliminate the negative real rate problem. At the same time, the real mortgage rate is low – a first-home buyer will pay about a 4.5% nominal rate (the PBoC benchmark 1Y loan rate discounted by 15%) for a 10-year mortgage.
This works out to 1% in real terms, using CPI inflation to deflate.
This means a property bubble will, over time, spill over in to the Tier 2 and Tier 3 cities. As soon as monetary policy is loosened, whether it is at the end of this year (as we expect) or later, or as soon as the central government signals even the mildest of loosening of housing policy,
we worry that house prices will rise again – particularly outside the Tier 1 cities, where prices are already pretty elevated.
Comments from an official at Shenyang People’s Bank (a branch of the PBoC) on the need for interest rate reforms have attracted much interest in recent weeks. His idea is to allow banks to offer higher deposit rates, starting off in north eastern China.
We are unsure how much backing this idea has from the leaders of the PBoC, but the comments highlights a long-running and frustrated ambition of many at the central bank to liberalise rates and raise them to nearer to China’s nominal growth rate. As we have explained in this note, interest rate liberalisation has happened in the nooks and crannies of the market, but the base rate system still dominates, and it is unreformed.
It strikes us that allowing one region of China to raise rates would not be easy, given the ease with which money moves around the country. We also believe that, given the ‘no-change’ macroeconomic stance of the State Council, it would be hard to persuade other ministries of the rationale for raising rates, whatever the medium-term benefits (though, of course,there will never be a ‘good’ time for rate reform).
We believe that this problem needs to be solved if China is to prevent a debilitating asset bubble from forming over the next five years.
Before the housing market existed, in the 1980s-1990s, liquidity had no choice but to sit idle in deposit accounts. Now a big housing market does exist, and deposits – even structured deposits – are not priced right.
Mortgages are cheap too. And that means money has no reason to stay at the bank, and every reason to continue flowing into the housing sector.
http://www.theedgemalaysia.com/business-news/173483-china--how-to-prevent-a-housing-bubble.html
