Rates to be fully freed in 2 years

China will lift all controls over interest rates in two years to follow up on its top leaders' announcement last November that they will allow the market to play a "decisive role" in the nation's economic development. So pledged Zhou Xiaochuan, governor of the People's Bank of China, the nation's central bank, on Tuesday as he met with the press on the sidelines of the annual session of the National People's Congress.

"Liberalization of deposit rates is on our agenda," Zhou said. "I personally believe this is likely to be done within a year or two." China already axed its control over lending rates in July 2013. Removing the control of deposit rates will make its rate liberalization complete. But experts said that such a reform will create an unprecedented challenge to China's major banks, all of them State-owned at the moment, in risk management.

Chinese commercial banks used to rely on interest rate spreads for easy profits, Wen Bin, director of macroeconomic research at the Bank of China's institute of international finance, pointed out. In 2013, they posted a profit of 1.42 trillion yuan ($231 billion), equal to 2.5 percent of the nation's total GDP.

Following the interest rate reform, however, banks' rate spread will inevitably narrow, and they will have to learn new ways of doing business, Wen said. As banks would be offering their most favorable rates to large corporate clients, they could charge higher rates only to clients from small and medium-sized enterprises. But lending to SMEs is less protected by collateral and third-party guarantees, and it would require a higher level of risk management on the part of the lenders. In a pre-emptive move, some commercial banks already have adopted new methods of risk management.

They are developing new customers among the SMEs along the supply chain of the large, more financially secure companies. The commercial banks also should diversify their sources of revenue by developing more intermediary businesses such as trade finance and capital transaction. Wen said China is in the process of establishing a deposit insurance system by creating a fund to better protect investors against possible failure of the banks.