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 August 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. In turn, that rate is linked to the price the People’s Bank of China
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 where 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 may be more willing to cut quasi policy rates to drive down
the LPR,” Lu Ting, chief China economist at Nomura International in Hong Kong
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.”
Bank stocks slipped Monday as analysts predicted lower
rates will make lending less profitable. Industrial & Commercial Bank of
China Ltd. fell as much as 2.2%, Bank of China Ltd. lost 1.4%, and Agricultural
Bank of China Ltd. dropped 1.2%.
Until
now, China has held off reducing its historical benchmark rate, the 1-year
lending rate, as such a step would have immediately re-ignited the frothy
property market and accelerated debt growth.
The
central bank said Saturday that commercial lenders submitting prices for the
calculation of the new LPR will report in terms of a spread on top of the
interest rate of the PBOC’s medium-term lending operations, currently at 3.3%.
As the current benchmark 1-year lending rate stands at 4.35%, new loans priced
from the LPR could carry a significant discount.
Officials
have said that the 1-year lending rate, which sets borrowing costs economy
wide, will ultimately be abolished. For now, interest rates on existing loans
and mortgages won’t be changed, according to the central bank.
The
reform will make the “overall lending rate for the real economy move downward,
which will achieve an effect similar to that of cutting interest rates,” Li
Qilin, chief economist at Lianxun Securities Co., wrote in a note. Its
effectiveness can only be seen in the pricing on Tuesday, he said.
The reform centers on making the one-year and five-year LPRs more
reflective of actual lending. The number of banks participating in the pricing
will be increased to 18 from 10, 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. and Standard
Chartered Bank China Ltd. are the two foreign lenders on the panel.
China’s
economy weakened more than expected in July after a brief bounce in the
previous month, and the effects of the trade war with the U.S. are expanding
into finance and the currency. While the PBOC has been providing liquidity to
the banking system to reduce inter-bank borrowing costs, the easing has only
passed through into the real economy to a limited extent.
“It’s
likely that small and micro-sized quality companies will benefit more” than
others from the reform, former central bank official Sheng Songcheng wrote in
an article posted on the PBOC-backed
Financial News. He also said the use of the MLF rate in forming the new LPR
will be temporary, and the PBOC will continue to cut the amount of money banks
have to set aside as reserves in the future.
Ultimately,
China may move toward a system where the short-term lending rate to banks is
the PBOC’s main monetary tool, though officials haven’t yet spelled that out.
For the time being, banks may 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 fueling housing prices or compromising financial stability,”
economists including Robin Xing at Morgan Stanley in Hong Kong wrote in a note.
“These measures are defensive in nature and may not fully offset the growth
drags. We thus continue to see downside risks to growth in 2H.”
Source: Bloomberg