In 1995, in Sanya City, China, the Rural Credit Union raised interest rates from

Question

In 1995, in Sanya City, China, the Rural Credit Union raised interest rates from 9.2% to 10.8% on one-year savings accounts, hoping to attract new deposits to the bank. Instead of attracting deposits, however, the change provoked its principal competitor, the Hainan Development Bank, to increase deposit rates as well. As a result, capital costs increased at both banks, without a corresponding increase in deposits, and profits declined.

a) Advocate as to whether you believe the government should step in here, or not?

b) What could the government do to improve the outcome, or make matters worse?

Explanation / Answer

At this point of time the governemnt has no reason to step in. By the sheer virtue of mounting losses, the banks would on their own either reduce the deposit rates or increase the loan rates. If the banks tend to increase the loan rates, the businesses will suffer from increased cost of capital. this is when the government should step in to free some liquidity or direct the banks to reduce loan rates.

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