Regulators in China gave more detail Tuesday on how they want to liberalize the banking system. The private sector will set up independent banks and rate caps on deposits could be lifted within two years.

The planned private banks, part of sweeping reform plans announced last year, are expected to operate independently and according to market principles, said Shang Fulin, chairman of the China Banking Regulatory Commission. He gave no timetable for when they would open or details of their intended size.

Reform advocates complain state banks hold back the economy by lending mostly to state industry, rather than to entrepreneurs who create new jobs and wealth. Interest paid on savings is low, effectively forcing Chinese households to subsidize politically favored borrowers.

“Extremely low interest rates made all of this possible. State-owned companies, which need a lot of money, can borrow as much as they want for little cost. Those who save their money—families and workers—are effectively subsidizing these operations through their bank deposits because they have few other places to put their money,” economist Tianlun Jian told Epoch Times.

Premier Li Keqiang, the country’s top economic official, promised this week to give market forces a “decisive role” in allocating credit and other resources in hopes of nurturing more sustainable long-term growth.

Jian said consumers mostly invest in real estate to get some yield and that this is not sustainable: “They do have one other place: Real estate. For most people, investment in real estate is the only place they can get a decent rate of return on their money, exceeding consumer price inflation. As a result, the massive investment into housing has created an enormous bubble.”

Investment in real estate accounted for 13 percent of China’s gross domestic product (GDP) in 2011, while revenue from land sales accounts for 30–50 percent of local government revenues.

New Banks
The new private banks should offer higher rates for depositors, according to market principles.

Each new bank must have at least two private investors, Shang said at a news conference held during the annual meeting of China’s legislature. He said preparatory work still was underway.

Two of the bank investors are Alibaba Group, one of the world’s biggest e-commerce companies, and Tencent Holdings Ltd., China’s most popular online games provider. Both have launched online financial services that have drawn deposits away from banks by paying higher interest.

In addition to Alibaba and Tencent, the ruling party newspaper People’s Daily said the 10 companies involved include Wanxiang Group, an auto parts maker; Fosun Group, a conglomerate that owns French tourism company Club Med; and Huabei Group, a real estate developer.

The new institutions will be expected to focus on lending to small- and medium-size companies, Shang said, using the ruling party’s term for private businesses. He said they will be required to have a “living will,” or plans to wind down a failed bank, to prevent the burden from falling on taxpayers.

The first banks will be located in Shanghai and the city of Tianjin, east of Beijing, and the southeastern provinces of Guangdong and Zhejiang.

Shadow Banking
A lack of lending by state banks to entrepreneurs has fueled growth of an underground market of high-interest loans. Regulators permitted the market in order to support private business but more recently have tried to tighten control over it after discovering state companies and banks were involved, exposing themselves to potential losses.

“A big problem of China’s banking sector is that state-owned banks extend most of their lending to state-owned companies. It is very difficult for small and micro-sized companies and private firms to get a loan,” Shen Jianguang from Mizuho Securities, told The New York Times.

In July, regulators scrapped controls on lending rates. That will allow borrowers with strong credit records to negotiate cheaper loans, lowering their costs and spurring economic growth.

Also Tuesday, the central bank governor said Beijing is likely to ease controls on interest rates paid on savings within two years. That would allow banks to compete for deposits and put more money in Chinese families’ pockets.

“Liberalization of deposit rates, this should be the last step in interest rate marketization,” said Zhou Xiaochuan. “I personally believe it is very possible to realize this within one to two years.”

However, it remains to be seen whether this initiative will succeed. Higher rates for depositors must mean higher rates on loans—or losses for banks. Both alternatives need to be avoided for further reforms to take place.

The cash-strapped and debt-laden Chinese corporate sector cannot afford higher rates on loans. And the Chinese regime can’t afford to bail out its state-owned banks.

The Associated Press contributed to this report.