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Friday, 24 October 2014

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China's PBOC serves reformists an amuse-bouche

China’s central bank has just whetted the appetites of reformists. The People’s Bank of China said on Friday that starting immediately it will let banks lend as cheaply as they like, removing the floor of around 6 percent for one-year loans. It smells like interest-rate liberalisation, but it’s only an amuse-bouche.

A lucky few will now have access to cheaper loans. About 15 percent of borrowers get rates below the benchmark. They are mainly connected clients like large state-owned enterprises and local government entities that can push local branch managers around. If they can force lending rates down, it would weaken the profitability of banks.

Distressed borrowers may get a second chance, too. Banks might prefer to extend cheaper credit to large customers on the brink than recognise the loans as duds, thus preventing some companies from going to the wall. In that sense, cutting the minimum lending rate may be less about the authorities letting markets work and more about ensuring they don’t.

For other borrowers, little should change. Banks can’t extend more than 75 percent of their deposit balances, and even those loans are subject to informal quotas. That leaves traditional credit in short supply – and priced accordingly. The PBOC already loosened rates a bit in June 2012. And yet, according to Credit Suisse data, a year later the eight biggest listed banks were still achieving the same 2.6 percent net interest margin.

The real meat, liberalising deposit rates, is still off the menu. China’s savers earn a mere 3 percent on their one-year savings, little more than the official inflation rate. So the liability side of bank balance sheets will remain the same, and savers will still crave alternative assets like property. Home prices increased by an alarming 6.8 percent in June from a year earlier, according to official data.

The bigger reforms are happening by stealth in China’s so-called shadow banking system, estimated by Standard & Poor’s at $3.7 trillion last year. It is already matching borrowers and lenders at market rates, away from banks’ visible balance sheets, creating much-needed funding but also incalculable risks. A Chinese big bang is being cooked up, just not by the People’s Bank.

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China’s central bank said from July 20 it would remove the floor on lending rates and the upper limit on lending for rural credit co-operatives. The People’s Bank of China said it would retain lower limits on mortgage lending rates to promote the “healthy development of the real estate market”.

Deposit rates would not be reformed for the time being, the bank said, because the requirements for liberalising the return on savings are higher. China’s banks cannot offer savers more than 110 percent of the mandated deposit rate, which for one-year deposits is 3 percent.

Before the reforms announced on July 19, banks could lend as low as 70 percent of the benchmark rate, which for one-year loans is 6 percent. In June, 21st Century Business Herald reported that just 15 percent of loans in 2013 had been priced below the benchmark rate.

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