China's moves to end a rule about loan-to-deposit ratios on banks is part of a continued drive to free up the country's capital markets, a large Scandinavian bank said.

A move by China to remove the loan-to-deposit ratio, or LDR, for commercial banks, currently at 75 per cent, will boost lending and economic growth as the country liberalises its financial markets, Scandinavian bank SEB says in a note.

The bank noted that the end of the LDR will be replaced by other ways of monitoring liquidity.

As of May, the ratio was at an average of 67.8 per cent; SEB says this level is not likely to be a true measure of banks’ liquidity conditions because they tend to reduce loans and hoard deposits towards the end of a month when the LDR is calculated. Bank also are struggling to attract deposits because other forms of savings, such as the wealth management products market, are seen as more attractive options.

SEB said the end of the ratio rule could happen as soon as two months from now, which means that there will continue to be month-end rises in rates in June and July.

Ending the ratio “will encourage banks to give more loans and support growth. Property and banks are the likely winners since banks can extend more loans, especially mortgage loans. Also, the smaller banks should benefit more since they have high LDR because they have [a] harder time attracting deposits (i.e. bigger is considered safer),” the bank said.  

“Second, it will smooth the interest rate curve and prevent the volatile, seasonal liquidity crunch (month end, quarter end). Smoother rates and less liquidity crunch will also support the equity market. Third, we will still need an interest rate or reserve requirement ratio cut short term to cushion the growth slowdown and allow maturing debt to be rolled over smoothly. Markets will continue to be disappointed on Mondays if cuts are not delivered over the weekends when China changes policy,” it said.

An LDR is used to measure how liquid a bank is: if a customer withdraws from a bank deposit but the bank has lent everything long term, it will have problems meeting the withdraw request. LDR measures this ability to meet liquidity needs. China’s LDR is low internationally because of its large deposit base.

In China, households and corporates are limited on where to park their savings and deposits are one of the limited choices. Financial market liberalisation and increasing the size of domestic equity and bond markets, as well as opening the capital account to access international financial markets, are solutions to give domestic savers more choices away from banks.