A Chinese central bank official has called for less restrictions on interest rates against a backdrop of worsening asset quality and shrinking profit growth among most lenders.

To free up interest rates, China could raise or even remove its upper limits on banks' deposit rates, said Sheng Songcheng, head of the central bank's statistics department, in an article published in Caixin Magazine last week.

"It could further expand or even remove the officially set floating range of medium- and long-term deposits, and then gradually expand the upper limit of short-term and small-sum deposits, until caps on such deposits are abolished," he said.

Guo Tianyong, a professor at Central University of Finance and Economics, applauded the plan. "The path is reasonable and could fend off risks because long-term and big-sum deposits are relatively more stable funds for banks," he said.

The People's Bank of China, the central bank, has been making efforts to liberalize interest rates as it promotes reform of the financial system and allows market forces to play a bigger role in determining the price of capital.

In 2004, the bank removed its lower limit on bank deposit rates and permitted lending rates among lenders to be 10 percent lower than the benchmark rates.

In June 2012, it allowed banks' deposit rates to be 10 percent higher than the benchmark rates, while cutting the lower limit of lending rates to 80 percent of the benchmark. In July, it further reduced the limit on lending rates to 70 percent.

Major banks could play a role in stabilizing interest rates, and China could use Western banking practices as a model, Sheng said. "We need to form a reference interest rate that could be efficiently regulated by the central bank through open-market operations, and has a strong impact on the market," he said.

Continued controls of interest rates could affect the stability of the yuan's exchange rate, and would bring risks to the foreign exchange market, he said.

In addition, current low deposit rates have partly driven housing investment and led to speculative bubbles, said Stephen Green, chief China economist at Standard Chartered Bank. However, higher deposit rates and lower lending rates after the authorities remove controls could eventually squeeze bank profits, analysts said.

Sheng warned that interest-rate liberalization would pose a greater risk to smaller lenders, as they would tend to raise deposit rates in the competition for funds, and prefer to extend riskier loans for higher profits.

Guo said: "Small lenders need to strengthen their capability of controlling and managing risks. On the other hand, deposit insurance and a bank bankruptcy system should be established to prevent their risks from spilling over to all of society."

A China Banking Association survey released in late December showed that more than 60 percent of the bankers surveyed said they believe the best time for the government to promote interest rate liberalization would be in three to five years.

Further interest rate liberalization would come from certain financial institutions, and would be achieved by loosening price restrictions on alternative financial products, central bank Governor Zhou Xiaochuan said in November.

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