China took a major step toward reforming its system of interest rates, in a move aimed at pushing down the cost of borrowing by households and companies as the economy slows.
From Aug. 20, new loans must be priced “mainly” with reference to a revamped benchmark that tracks the price of credit to banks’ best customers, the so-called loan prime rate (LPR). In turn, that rate is linked to the price that the People’s Bank of China (PBOC) charges lenders for cash over one year.
The changes push China’s financial system further toward being truly market-led, and away from the communist-era command economy, during which officials set both the price and quantity of credit.
By unifying market and official rates, the PBOC also intends to bring down the stubbornly high cost of borrowing and aid pass-through of future changes in policy rates.
“As the transmission channel will to some extent be improved, the PBOC might be more willing to cut quasi policy rates to drive down the LPR,” Nomura International chief China economist Lu Ting (陸挺) wrote in a note. “We expect riskless rates and government bond yields to drop further as the PBOC catches up with other central banks in rate cutting.”
Until now, China has held off reducing its historical benchmark rate, the one-year lending rate, as such a step would have immediately reignited the frothy property market and accelerated debt growth.
The central bank on Saturday said that commercial lenders submitting prices for the calculation of the new LPR would report in terms of a spread on top of the interest rate of the PBOC’s medium-term lending operations, currently at 3.3 percent.
As the current benchmark one-year lending rate stands at 4.35 percent, new loans priced from the LPR could carry a significant discount.
The reform would make the “overall lending rate for the real economy move downward, which will achieve an effect similar to that of cutting interest rates,” Lianxun Securities Co (聯訊證券) chief economist Li Qilin (李奇霖) wrote in a note.
Its effectiveness can only be seen in the pricing today, he added.
The reform focuses on making the one-year and five-year LPRs more reflective of actual lending.
The number of banks participating in the pricing would be increased from 10 to 18, with the types of lenders expanded to include city and rural commercial lenders, foreign lenders with operations in China and privately owned lenders, the central bank said.
Citibank China Co Ltd (花旗中國) and Standard Chartered Bank China Ltd (渣打中國) are the two foreign lenders on the panel.
“It’s likely that small and micro-sized quality companies will benefit more” than others from the reform, former central bank official Sheng Songcheng (盛松成) wrote in an article posted on the PBOC-backed Financial News.
China might ultimately move toward a system in which the short-term lending rate to banks is the PBOC’s main monetary tool, although officials have not yet spelled that out. For the time being, banks might be reluctant to immediately pass through large reductions in borrowing costs, as margins are under pressure as the economy slows.
“Policymakers are walking a very fine line this year, aiming to ease corporate borrowing costs but not fuel housing prices or compromise financial stability,” Hong Kong-based Morgan Stanley economists, including Robin Xing (邢自強), wrote in a note.
“These measures are defensive in nature and might not fully offset the growth drags. We thus continue to see downside risks to growth” in the second half of this year, the economists added.
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