Freeing up interest rates in China is essential for the long-term health of the Asian country’s banking regime but in the short-run Mainland China commercial banks, especially smaller ones, will see a significant impact, a senior banking figure has said.

Dr Liao Qun, chief economist and general manager at the research department of China CITIC Bank International, has set out a report about how interest rate liberalisation will affect banks in two ways. On one side, liberalisation will see interest rate levels on lending and deposits change, with margin adjustments towards bank profitability. This will lead to a strategic shift in business expansion and increases in credit risk. The other route will increase interest rate volatility and stimulate repricing risk, basis risk, yield curve risk and optionality risk.

Small- and medium-sized banks will become more vulnerable to the impacts owing to their disadvantages in business network, branding, reliance on spread income, service scope and capability, risk management standards and internal governance, the report says. Conversely, large banks will respond to such effects by changing their business models.

The mainland banking sector will face restructuring pressure. Market concentration will increase in the short and medium terms and decline in the long run as the market opens up, he says.