Question

The author writes: “Still, as long as interest on deposits is capped by the government, Chinese savings will continue to be invested in riskier and higher-yielding products, adding to distortions in the financial system.” Why? Explain

Answer 1

In China the interest on deposits is capped by the government. Investors and the general public are looking our for higher interest rates now that would yield them a greater benefit than the investments made in banks or other government initiatives. The ceiling on the deposit rate and the floor on the bank lending rates has helped banks to pocket large profits but has even worsened the scenario for investors as they are no longer willing to invest in banks as their value of cash deposits have deteriorated. This has acted like a tax on savers. Thus people have now started investing in riskier products like art, gold, property, financial leasing companies, trust companies. The money is used to finance high interest loans to private developers. Investors are also turning towards online investment which exposes weakness of China's Financial system. Banks are short of cash due to which interbank rates are going up, this is a sign of stress in the banking and financial system where these institutions could default leading in huge financial losses and defaults thereby distorting the financial system as a whole and create crises for the country and nation as a whole if this is not resolved in time.