China unveils rate reform to help lower firms' borrowing costs

China unveils rate reform to help lower firms' borrowing costs

China unveils rate reform to help lower firms' borrowing costs

The central bank said in the statement that it would be committed to "deepening market-based interest rate reform, improving the efficiency of interest rate transmission, and lower financing costs of the real economy". Rates will be published on a monthly basis.

In point of fact, recent reform of China's Central Bank came forth a few days after China's industrial activity fell to a 17-year low, which eventually prompted the People's bank of China to ease policy further including a reform of its core interest rate. Banks have to refer to such rate as guidance, while the central bank has maintained a strong say in determining the cost of corporate loans.

The central bank said it will improve the mechanism used to establish the LPR from this month, in a move to further cut real interest rates for companies as part of broader market reforms. China will add eight small banks, including two foreign-funded banks, to the existing 10 nation-wide banks that will be allowed to submit LPR quotations, the central bank said. And the formation of LPR will be priced on a +/- basis point basis from open market operation interest rates. The central bank said that it will strengthen its supervision on banks' rate quotations and punish banks for irregularities that disrupt the market order.

At the same time, China's continuing trade war with the USA shows no signs of abating, adding to concerns about a further deceleration in the domestic economy. Banks will retain discretion as to how they price rates for loans maturities of less than 1-year and within 1-5 years. Second-quarter economic growth slowed to a near 30-year low.

"We expect the PBOC to have more incentive to lower MLF rates and other quasi-policy rates, but we believe the PBOC's capability to reduce banks' lending rates is quite limited due to restraints on credit growth as well as banks' vulnerability", said Lu Ting, chief China economist at Nomura in Hong Kong.

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Ming Ming, head of fixed income research at CITIC Securities in Beijing, said he expects the first new rate will be set lower to narrow the yield gap between LPR and interest rate on the MLF, which is now 3.3 per cent.

The PBOC said that the move aims to make LPRs a more market-oriented mechanism and break the implicit floor on lending rates so as to lower borrowing costs in the real economy. Sources have told Reuters that more aggressive action such as interest rate cuts are a last resort, as it could fuel a sharper build-up in debt. China's banks now price their loans based on the benchmark lending rate that has been kept unchanged since October 2015, hampering the central bank's efforts to lower borrowing costs. But the LPR has been reacting little to market demand and supply, with the one-year rate now at 4.31%, versus benchmark one-year lending rate of 4.35%.

The LPR, originally introduced by the People's Bank of China (PBOC) in October 2013, is an interest rate that commercial banks charge their best clients and was meant to better reflect market demand for funds than the benchmark the PBOC sets.

But existing loans will still follow the original contracts that were signed in line with the benchmark lending rate.

Most central banks govern the price of money in an economy via the rate which banks are charged to borrow cash over short periods.

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