Midsize banks to benefit from launch of CD market

Midsize banks are likely to benefit from the launch of a certificates of deposits market, announced by the central bank this week, given their greater reliance on short-term wholesale funding than the rest of the industry, Standard & Poor's Ratings Services said in a report.

The People's Bank of China officially launched the CD market on Dec 9, following the release of the reform blueprint of the central government last month.

Under the new guidelines, Chinese banks will be allowed to issue CDs at market rates to all participants in the domestic interbank market, and licensed domestic fund managers and their funds.

"The launch of the CD market is likely to be conducive to the liquidity management of Chinese banks because it broadens their funding and investment toolkits. We also expect cost-savings for issuers because premiums for liquidity risks may be reduced," said Standard & Poor's Senior Director Qiang Liao.

CDs could be attractive from a creditors' perspective because of the enhanced liquidity from a secondary market. One-month Shanghai Interbank Offering Rates dropped for several days after the CD market launch.

The CD market will give Chinese banks a more reliable and cost-saving funding avenue than interbank borrowing.

Given that the CDs will not be directly available to retail and corporate depositors at this stage, any meaningful substitution effect is not expected to drive up the banks' funding costs. However, the CD market may encourage greater competition from money market funds against bank deposits, and that may indirectly affect Chinese banks' funding costs.

The launch of the CD market is also in line with policymakers' intention of further liberalizing interest rates. The central bank appears to be targeting wider use of market-based interbank rates, given that the CDs are defined as money market products with pricing to be referenced to Shanghai Interbank Offering Rates.

"We expect the central bank to continue to gradually press ahead with interest rate liberalization and other reforms. In our opinion, Chinese policymakers have tried to strike a delicate balance between deregulating deposit rates and protecting the banks' ability for earnings capacity to absorb credit losses," said Liao.