Another step toward China's interest rate liberalization

Negotiable certificates of deposit (CDs) are to return to the Chinese capital market after 18 years, marking a further step forward for China's interest rate liberalization.

Considering the country's overall plans for reforming its interest rate mechanism, China is likely to form an interest rate mechanism fully determined by the market within a year or two so that it can push ahead with its financial reforms.

The world's first negotiable CDs appeared in the United States. In the 1960s, the US inflation rate soared, but a cap remained on rates of interest on bank deposits. In order to prevent deposit outflow, First National City Bank of New York, now Citibank, introduced negotiable CDs in 1961, enabling large banks to attract corporate depositors' short-term idle money.

Compared with traditional CDs, negotiable CDs have advantages:

Negotiable CDs are a standardized investment product with specific denominations, usually large ones, while with traditional CDs, investors determine how much money they would like to put into the account.

Although negotiable CDs do not allow early withdrawal, they enjoy high liquidity and can be sold on secondary markets. With traditional DCs, investors can withdraw their principal and interest upon maturity and any early withdrawal is subject to penalties.

Negotiable CDs usually have high interest rates, and rates on the secondary markets are determined by the capital market's supply and demand at the time of selling, which is also regarded as one of the stages in the process of interest rate liberalization.

The market-determined interest rate mechanism will efficiently curb the expansion of shadow banking, facilitating the financial system to better serve the real economy.

It also will help push forward reforms of commercial banks, boosting the growth of various financial markets and giving full play to their functions.

To sum up, we should set up a market-determined interest rate mechanism as early as possible so that China can eventually achieve its financial market reform goals.

The author is a certified financial planner and independent commentator. The views do not necessarily reflect those of China Daily.

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