Chinese banking authorities have started a pilot program at China Merchants Bank (CMB) to liberalize its deposit rates as the nation accelerates its step to float interest rates, a source familiar with the matter told China Daily.

CMB is the only major commercial bank chosen for the trial, among a few small-scale city commercial banks, largely because it has sound innovation abilities to counter risks, as the reform would see deposit rates increase and the net interest margin shrink, said the source, who did not wish to be identified owing to the sensitivity of the matter.

The pilot program began two months ago, the source said.

Mainly targeting insurance companies and big companies that usually have fixed large deposits in banks, the central bank is working on a price-bidding system for deposits with a maturity of no more than five years among pilot banks before extending it to other financial institutions that would be allowed to set interest rates freely in accordance with the market situation.

"Among deposit rates, those for corporate agreement deposits (contracted savings between banks and their clients) with maturity of more than five years are already liberalized. The system is aiming to open up pricing limits for the short- and medium-term deposits," said the source.

China will liberalize market-oriented interest rates by allowing qualified financial institutions to price their products in the next five years, and set up a mature mechanism to guarantee a concerted application of the central bank's monetary stance, said Zhou Xiaochuan, governor of the People's Bank of China, at a forum in December.

"During the 12th Five-Year Plan (2011-2015), we expect to see significant progress in interest-rate liberalization," he said, adding that most lending rates in the country have already been liberalized but limits on deposit rates need to be further freed.

Wu Zhengzhang, chief representative of Shenzhen Development Bank, Beijing Branch, said the central bank is always cautious about any new move, and the pilot program should be conducted within the scope of small banks that have fewer clients and would see limited repercussions if problems were to occur.

He predicted that three to six months would be needed before such a pilot program could be applied at the major banks. "But it is still very hard to say whether the interest rate liberalization can make substantial progress in 2011."

Lu Zhengwei, chief economist with the Industrial Bank, said it will be a breakthrough in the liberalization reform to find a market-based pricing reference for deposit and lending rates.

"We can try to allow banks with the highest credit rating, such as the Shanghai Interbank Offered Rate (SHIBOR) members, to issue certificates of deposit with standardized contracts, appropriate amounts, and diversified terms based on SHIBOR, to find a reference price for deposit rates," he suggested.

The central bank is also on track to establish a deposit insurance system to strengthen risk management in the financial sector.

Lu said the establishment of the deposit insurance system will pave the way for interest-rate liberalization, as market-oriented interest rates may widen the performance gap between banks and place depositors at risk.

"The commercial banks should prepare themselves for potential losses caused by self-determined interest rates and be prepared to take full responsibility in the future," central bank governor Zhou said earlier this year.

He emphasized that Chinese policy banks and other institutions without rigid financial requirements will not be allowed to price their interest rates as freely as the commercial banks.

Chinese banks have traditionally relied heavily on the interest gap between savings and lending for profits. The reform towards market-based interest rates would help the nation better allocate its financial resources and make commercial banks more independent and efficient, analysts said.