China Removes the Floor on Lending Rates

Commercial banks in China will now have the freedom to compete for borrowers, after the People's Bank of China (PBOC) announced it would remove controls on bank lending rates.

 

The change, effective July 20, removes a floor set at 30 percent below the current 6 percent benchmark. The central bank left a deposit-rate cap unchanged. Also, monetary aggregates will for now continue to be steered by quantitative levers such as credit quota and loan to deposit ratios rather than by interest rates.

 

China has traditionally controlled lending and deposit interest rates. The shift will lower companies’ funding costs and boost financial institutions’ pricing capabilities, the PBOC said. In March, only 11 percent of loans were priced below the lending benchmark, according to central bank data.

 

"This important step in the liberalisation of interest rates shows the seriousness (and mandate) of the government in the area of financial and monetary reform," says the The Royal Bank of Scotland. "It will over time move the monetary and financial framework towards a larger role for the interest rate in allocating capital and introduce more competition in the financial system."

 

The economic impact of the new policy is likely to be modest, says the RBS. In Q1 2013 only 11% of bank loans was extended at lending rates lower than the benchmark.

 

The RBS also said that the step is unlikely to have a major immediate impact on lending volumes. That is in part because the quantitative levers have been the binding policy levers and they have not changed.

 

Also, corporate borrowing is affected a lot by subdued demand in a context of weak profits and spare capacity in many sectors rather than the lending rate.

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