Debang Securities: Looking at China's interest rate system from the perspective of liabilities, focusing on the space for cost reduction by 2025.

Debon securities released a research report stating that during the process of broad-based interest rate decline, asset management institutions need to pay attention to the asset allocation adjustments caused by the decrease in asset yields, and also need to focus on the risks and opportunities brought by changes in the cost of liabilities. To cope with the low interest rate environment, asset management institutions need to actively engage in liability management to attract low-cost liabilities with greater efforts, stabilize customer base, ensure stable liabilities, and achieve long-term sustainable development. Debon Securities' main points are as follows: 1. China's interest rate system China's interest rate system mainly includes the deposit and loan interest rate system and the financial market interest rate system. The deposit and loan interest rate system involves banks as intermediaries, matching funds indirectly between supply and demand; the financial market interest rate is formed through direct trading where supply and demand match. In between these two chains, the bank's FTP pricing mechanism establishes a pricing relationship between loan interest rates and financial market rates. Central bank interest rate corridor: the excess reserve interest rate is the lower limit, reverse repurchase rate is the central rate, and standing lending facility (SLF) rate is the upper limit. The excess reserve interest rate can be seen as the lower limit of the current central bank policy interest rate corridor, currently at 0.35%; the 7-day reverse repurchase rate has become the main policy interest rate, with a rate of 1.5% as of February 5, 2025; the SLF rate is the upper limit of the current interest rate corridor, with the 7-day SLF rate at 2.5% as of February 5, 2025. Funds rate: Reflects changes in interbank liquidity supply and demand, with R, DR, and SHIBOR as the main reference targets. Due to the existence of the central bank open market operation primary dealers system, liquidity is mainly transmitted from large banks to small and medium-sized banks and non-bank institutions, resulting in various funding rates. In practice, R, DR, and SHIBOR are the main funding rates. In 2024, most funding rates decreased and fluctuated less, reflecting the ample and stable non-bank funds in 2024. Compared to the decrease in the central rate of the funds rate, the more important thing is the significant reduction in the fluctuation range of the funds rate, which indicates that the ample and stable liquidity environment is a secure guarantee for increasing the allocation of risk-free and low-risk bonds. Deposit and loan rates: Connect financial institutions with the real economy and directly reflect financial support to the real economy. Continuous reductions in deposit rates have been the core driver of the decline in the liability costs of financial institutions, especially noteworthy is the impact that adjustments in specific deposit rates may have on the overall liability costs. Thanks to the continuous decline in the loan prime rate (LPR) since its reform and the expansion of single decrease in 2024, the actual financing cost for entities has been effectively reduced. For banks, the decline in loan rates, which are the main substitute for bonds, has also become a driver for increasing bond allocations. 2. Understanding the interest rate system from the liabilities side of financial institutions Banks: Deposits are king. In December 2024, deposits accounted for over 86% of funding sources for deposit-type financial institutions, indicating that deposits are the most important component of bank liabilities, with deposit rates having the most significant impact on the liability costs. Since 2022, deposit rates have undergone multiple rounds of reductions, with both current and fixed-term deposit rates significantly decreasing, leading to an effective reduction in the liability costs of deposit-type financial institutions. Insurance: Key rate is the guaranteed rate. For insurance companies, their liabilities correspond to the portion of insurance products purchased by policyholders, and the liability cost rate corresponds to the yield provided by insurance products, with the "guaranteed rate" being the main reference point. For most of history, the guaranteed rate has been stable, with several rounds of adjustments at specific times. 2023 marked the beginning of this round of guaranteed rate adjustments, with the guaranteed rates for traditional insurance, dividend insurance, and universal insurance being 2.5%, 2.0%, and 1.5% respectively as of the end of 2024, with the latest research value for the fourth quarter of 2024 being 2.34%. Insurance asset management: Diversified operations open up limitations on liability costs. The liability costs for insurance asset management are determined by their funding sources, which can be divided into three categories: insurance funds, bank funds, and pension funds. The liability costs for insurance funds and bank funds are determined by insurance guaranteed rates and deposit rates respectively, while pension funds do not have a concept of rigid costs. The proportion of third-party funding sources outside of insurance in insurance asset management is increasing, especially with the rise in the proportion of pension funds, indicating an increase in the proportion of non-rigid cost liabilities, which is expected to enhance the flexibility of overall liability costs for insurance asset management, with positive implications for more diversified and flexible operations. Wealth management, subsidiary wealth management, mutual funds: Breaking the rigidity of liabilities, "voting with their feet" based on expected returns. The liabilities of wealth management, subsidiary wealth management companies, and mutual funds correspond to the shares of wealth management and fund products purchased by investors, and the liability cost rate corresponds to the return rate obtained by investors. After the new asset management regulations, banks' wealth management business, subsidiary wealth management companies, mutual funds, and other asset management institutions involved in asset management business must implement net asset value management, breaking the rigidity of liability costs. Although the return rate of products is not guaranteed, investors can "vote with their feet" through changes in relative return rates between different products and comparing them with other products such as deposits. 3. How liabilities affect changes in interest rates - several DRIVES for the bond bull From the liabilities side, there are several main DRIVERS for the bond bull in 2024: firstly, as deposit rates continue to decline and the central bank reduces interest rates through open market tools, the cost of bank liabilities decreases, making banks more accepting of declining bond returns; secondly, the reduction in insurance guaranteed rates means a decrease in the rigid costs of insurance liabilities, increasing the tolerance of insurance funds for declining asset returns; thirdly, in a low interest rate environment, changes in resident asset allocation behavior occur, where non-net asset-backed insurance and wealth management products become effective substitutes for fixed-term deposits; fourthly, the tightening of regulation on notice deposits, agreement deposits, interbank deposits may compress arbitrage opportunities, leading to a rush for interest rate bonds. Looking at the balance between the assets and liabilities of financial institutions, a decline in asset yields requires a corresponding reduction in liability costs to be realized. Since 2024, there has been a accelerated decrease in the liability costs of financial institutions, which may be the core driving factor of the bond bull, as the decrease in liability costs means that financial institutions are more tolerant of declining asset yields. For 2025, it is important to pay attention to the space for lowering liability costs; if commercial banks can stabilize their net interest margin, the willingness to lower deposit rates through the self-regulation mechanism may decrease.The cessation of deposit rate cuts may have a negative impact on the bond market, especially in terms of expectations. Market expectations for downward space for government bond yields may be compressed, prompting attention to this interest rate risk.4. How does changes in interest rates on the liability side affect the asset management industry? From the perspective of the balance between assets and liabilities in financial institutions, the downward adjustment of asset yield rates requires corresponding pressure on the cost of liabilities. The profound impact of a broad spectrum interest rate decrease on the asset management industry, the most direct implication being that the decrease in asset yield rates leads to a decrease in the return rate that asset management products can provide. From the perspective of liabilities, a decrease in interest rates also has profound implications for asset management institutions. In a phase of declining interest rates, it is necessary to pay attention in advance to adjusting and positioning the liability side. Finding a better way to manage liabilities in a low-interest rate environment is urgent. Asset management institutions need to actively manage the liability side to stabilize their client base and find low-cost liabilities. From the perspective of duration, as the interest rate declines broadly, short-duration assets will gradually lose their allocation value, and asset management institutions will need to rely on long-duration for returns. This means that the duration of assets will need to be extended, increasing the demand for duration on the liability side. Asset management institutions that mainly rely on short-duration liabilities will face greater operational difficulties, and the survival space for institutions specializing in short-duration liabilities, such as investment trusts, may gradually shrink. The contraction of the survival space for some asset management institutions may further lead to a decreased demand for employees in the industry, and an increase in industry concentration. Risk warning: unexpected changes in domestic monetary policy; changes in regulatory policies affecting the asset management industry; unexpected events such as a surge in redemption of wealth management products.