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When your Bank Interest is a Basketful of Vegetables

by Brian Viard

January 13, 2015

Want veggies? Open a bank account.

CKGSB professor Brian Viard on why Chinese banks are resorting to paying bank interest through Mercedes Benz cars, iPhones and even vegetables.

Before the advent of money, bartering was used for transactions. Someone who wanted a cow but owned a chicken they didn’t want would find someone with the opposite desires or traded the chicken for a third good which could later be traded for a cow. The advent of money eliminated this complicated system of buyers and sellers looking for matches. Because of the overwhelming increase in efficiency all modern economies use money as a medium of exchange—at least usually.

Governments sometimes force people to return to bartering by interfering with normal market functions. A case in point is China’s banking industry. Although the central government has stated its intention to liberalize the banking sector by 2016, it currently regulates the amount of interest that banks can pay depositors. Banks can pay up to 120% of a benchmark one-year deposit rate set by the People’s Bank of China but not above. The benchmark rate is currently 2.75% meaning that banks can pay no more than 3.3% annually to depositors. This is not a problem as long as banks can find sufficient deposits to fund their loans at rates below this. However, if higher rates are required, then the banks are in a bind.

Unable to use money, some banks have resorted to bartering. In lieu of interest banks are paying depositors with iPhones, vacations, Mercedes-Benzs, and even vegetables in order to attract their money. This has become necessary because alternative forms of savings available to depositors have pushed up rates. Internet funds have emerged that offer higher interest rates and have attracted significant funds: Alipay’s Yu’e Bao garnered RMB 535 billion in its first 15 months of operation. High-yield trust products, part of China’s shadow banking sector, offer higher yields (but also risk) on underlying investments such as real estate and development projects. The recent surge in the Shanghai stock market has also pulled savings away from banks. Because these alternatives are unregulated they offer higher rates than the traditional banks who cannot respond by raising their own rates. “Gifts” to depositors fill this gap.

Although presented as “gifts” to avoid violating regulations,[1] these giveaways still follow market forces. Their use increases when the regulated rate is below the market and slow when it is above. Also, the gift value is commensurate with the size of the deposit. Ping An Bank offers a 128-gigabyte iPhone 6 Plus for depositing RMB 38,000 for five years (with no formal interest). Given a market price for the iPhone of about RMB 7,700 this implies an annual interest rate around 4%—above the regulated rate. Deposit more and you get a bigger gift. Depositing RMB 903,000 for five years gives you a Mercedes Benz. At a current market price of about RMB 252,000 for a Mercedes this yields a 5% annual interest rate.

This reflects an important economic principle: when price is regulated, firms will try to compete on non-price dimensions. This has a long history. Under regulation by the Civil Aeronautics Board beginning in 1938 airline prices in the US were kept above market. Unable to lower prices, airlines competed on service. Airlines increased flight frequencies between city pairs to increase convenience, operated with lower load factors to increase seat availability, and used newer airplanes. Once deregulated in 1978, airlines quickly shifted to price competition. Prices fell dramatically; load factors increased; frequent point-to-point flights were replaced by hub-and-spoke systems; and planes were utilized longer.

China’s banking regulation also has a precedent in the US. From 1933 to 1986, Regulation Q imposed maximum interest rates on most bank deposits. US banks then reacted similarly to Chinese banks now. Unable to offer higher deposit rates, banks offered gifts. One gift in particular was so ubiquitous that it is inextricably linked to banks—the toaster.

These gifts are inefficient for the same reason that the barter system faded. Using money is a more efficient way to conduct transactions. Receiving a Mercedes Benz might be nice but some people may prefer a BMW or nice vacations. Some people receiving an iPhone may already have one and not need another. The gifts can be sold and the proceeds used to buy something else but this involves significant effort and costs for depositors. Liberalization of China’s banking industry would bring many benefits—among them the end of gift-giving.


[1] The China Banking Regulatory Commission bans “illicit” deposit-gathering practices but has not yet clarified whether product giveaways in lieu of interest are allowed.

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