8 Economists' Investment Tips
Xu Xiaoqing: “The Ten-Year Interest Rate Method” - China's Interest Rate System and Benchmark Interest Rate
Summary of this issue
Interest rates must correspond to both parties. Some people borrow money and others pay money. The interest rate is the price of this amount of money.
When talking about interest rates, the first question we need to clarify is: What is the benchmark interest rate?
Do you know how much interest rates are on one-year deposits now? I don't think many people will know
China's interest rate system (divided according to the parties involved)
Let's start with the interest rate cycle. First, let me introduce you to the interest rate system in China.
We know that interest rates must correspond to both parties. Some people borrow money and others pay, and the interest rate is the price of this amount of money. So simply put, we can divide all interest rate systems in China according to the two parties involved.
For example, interest rates between central banks and financial institutions include positive and reverse repurchases carried out by the central bank through the open market, various innovative tools to facilitate financing, such as what is commonly known as hot and sour powder (SLF), spicy powder (MLF), past central bank note interest rates, and treasury cash deposit tender interest rates and reserve interest rates.
The interest rate among financial institutions is the most familiar interest rate. It is also the main interest rate in the money market, including repurchase interest rates, loan interest rates, and interbank deposit interest rates.
The last type is interest rates between financial institutions and entities, such as the yield on wealth management products provided by banks to residents, interest rates on deposits, and interest rates on mortgage loans that banks lend to residents.
Companies borrowing money from banks also generate loan benchmark interest rates and weighted interest rates, as well as discounted interest rates for discounting notes, interest rates on various credit bonds issued by enterprises, and non-standard interest rates for financing through trusts and entrustment loans.
The government also generates interest rates when issuing bonds through financial institutions. Among them, the central government issues treasury bonds, local government bonds, and bonds issued by various quasi-government credit institutions. In China, the three main quasi-government credit institutions are the three policy banks.
These are the main interest rate systems in China.
What is the base interest rate?
Generally speaking, these interest rates can also be divided into two categories. The first category is called risk-free interest rates. This no-risk means no credit risk, that is, there is no risk of default, but it's not really risk-free. For example, if you buy a long-term treasury bond, can you say that it is risk-free?
It definitely has interest rate risk. When interest rates rise and fall, the price of long-term treasury bonds will definitely fluctuate greatly; you can just hold them at maturity to get back the full principal amount. So a risk-free interest rate actually mainly means no credit risk. Well, all interest rates with credit risk are risk-free interest rates plus a credit risk premium, which is what we call a credit spread.
But when talking about interest rates, we first need to clarify one question: What is the benchmark interest rate? Or what is the relationship between the benchmark interest rate and the risk-free interest rate? Is the benchmark interest rate just a risk-free interest rate?
A risk-free interest rate is actually a set of interest rates, because you can say how much is a one-month risk-free interest rate, how much is a three-month risk-free interest rate, how much is a one-year risk-free interest rate, and how much is a ten-year risk-free interest rate. It's actually a set of data. And this set of data forms a curve called the risk-free interest rate curve. However, there is only one benchmark interest rate, which means that the benchmark interest rate is actually the most basic of all risk-free interest rates. The question is why it is called the benchmark interest rate, and what characteristics should a benchmark interest rate have.
3 characteristics of the benchmark interest rate
The benchmark interest rate is the interest rate that the central bank increases or decreases when requesting interest rate increases or decreases during monetary policy regulation.
Benchmark interest rates need to have at least two main characteristics. The first one is that it is decided by the central bank, that is, if the central bank says what level this interest rate reaches, it can reach what level. If the central bank says nothing, or can only influence it indirectly, then it cannot be called the benchmark interest rate.
The second characteristic is that it affects all other interest rates. The reason it is called the base interest rate is that it can cause all other interest rates to move along with it.
What's another very important characteristic? The benchmark interest rate is actually a market-based interest rate, not an administrative interest rate.
I don't know if anyone has noticed, for example, the US benchmark interest rate. Everyone knows it's called the federal funds interest rate. What is it? It is an overnight interest rate between financial institutions. This is a market interest rate. The so-called market interest rate means that even without a central bank, this interest rate has a price, and is not created by the central bank itself. Many people probably think that the benchmark interest rate is the interest rate given to financial institutions by the central bank. This idea is incorrect. The benchmark interest rate must represent the financial institution's cost, and it is traded by the financial institution itself; it is a market interest rate.
Since it is a market interest rate, then if the central bank wants to influence this interest rate, in fact, it can only use market-based means, and not by issuing an official document requiring all financial institutions to borrow according to the interest rate level specified by it. How is this possible?
So every time we see the Federal Reserve say that it is raising interest rates, it means that we hope everyone's overnight lending rate can reach the level it needs. However, if you want the interest rate to reach the level it needs, you must do some things, so it actually operates through an open market and then puts in and returns some liquidity, so that the market interest rate is as close as possible to the target value it needs to achieve.
Therefore, every time the Federal Reserve raises interest rates, the overnight lending rate will have an actual value. This actual value actually deviates from the target value. It is not completely consistent, but it will be very close.
In this way, it is easy for us to understand why China's benchmark interest rate cannot be a one-year deposit interest rate in the future? We know that historically speaking, China's benchmark interest rate is the one-year deposit interest rate. Because the one-year deposit interest rate is a policy interest rate, which means that the central bank used to raise and cut interest rates, including now, it actually requires all banks to adjust according to the level of interest rates on one-year deposits; it is not a market-based interest rate.
Do you know how much interest rates are on one-year deposits now?
I don't think many people will know. What does that mean? It means that people don't care about it at all. Since I don't care about it, can I still say it's the benchmark interest rate? If people don't care about it, it means it has no impact on everyone's lives.
What are people more concerned about? Probably what is the yield of the balance bank because it is closely related to everyone's lives. Yubao's yield fell back from 4% to 3%. Everyone knows that the real benchmark interest rate must be a market-based interest rate. But in China, what is the real market-based interest rate traded by financial institutions? It's the interest rate in the money market.
That is the content of this course, thank you all.
This issue's guests:
