PBoC cuts rates and moves to address ‘informal lending’

The People's Bank of China (PBoC) lowered its main benchmark rates by 25 basis points on June 8, the first cuts since 2008. The central bank also adjusted its floating band for lending and deposit rates, which some observers believe is the first step to tackling risks posed by a burgeoning 'informal lending' market in China.

The move by the PBoC has resulted in the one-year deposit rate in the country now standing at 3.25%; while the one-year lending rate is now 6.31%. The floating band, which places a limit on the interest banks can charge or give to their customers, now stands at 0.8 times and 1.1 times versus benchmark rates.

The PBoC announcement on June 7 came as a surprise to many observers, who had expected the central bank to continue to ease its bank reserve requirement ratio – and some analysts still expect a further 200bp easing of this ratio in the near term. However, the positive market sentiment generated by the move was said to be cancelled out by a lack of any commitment to new policy stimulus by the heads of the Bank of England, European Central Bank and Federal Reserve this week.

"While the impact is likely to be limited, it does show Beijing is willing to do whatever it takes to support growth and to boost confidence," said Qu Hongbin, co-head of Asian economics research, and Sun Junwei, China economist, at HSBC in a research note. "Get ready for more decisive easing."

The central bank was given some room for manoeuvre on mainstream monetary policy as the rate of inflation in China, measured by the consumer price index (CPI), is on a downward trend. "[The] market should not be surprised to see weaker growth data and an even faster drop of inflation in May's set of data releases," said the HSBC analysts. The latest economic data will be released over the weekend of June 9–10.

This, plus the recent widening of the renminbi's exchange rate trading band and steps towards capital account liberalisation also implies that Beijing is getting ready to step up its pace of financial reforms

Bank analyst consensus is for year-on-year inflation in May to be 3.2%, with HSBC saying it expects this trend to continue with inflation falling further to 3% for June.

Standard Chartered analysts Stephen Green and Wei Li viewed the shift in the floating bands for bank lending and deposit taking as marking "a significant step forward in interest rate reform" in China. "In the past, banks were not allowed to (officially) offer saving rates higher than the benchmark rate (though wealth management products allow a way around this limitation)," the analysts said in a research report.

Now banks can offer saving rates of up to 1.1 times the benchmark rate and offer loans at a 20% discount to the benchmark rate, compared with a 10% discount in the past.

"China has for a long time suffered from a mismatch between loan supply and demand, with banks preferring not to lend to higher risk areas such as SMEs, instead extending loans to cashed-up, state-owned enterprises that do not need these loans," said Gigi Chan, a fund manager covering Asian equities at Threadneedle.

This has led to the creation of a multi-billion US dollar 'informal lending' market in the country, with loans offered by non-banks sometimes carrying interest rates in excess of 100% a year. While the latest moves are likely just to scratch the surface of the problem, "interest rate deregulation will mean risks can be more accurately priced by banks and means that credit can go to areas where it is most needed", said Chan.

HSBC's Qu and Sun were also upbeat, saying the widening of bands suggests "the PBoC has resumed its interest rate liberalisation process, stalled since 2004". "This, plus the recent widening of the renminbi's exchange rate trading band and steps towards capital account liberalisation also implies that Beijing is getting ready to step up its pace of financial reforms," the analysts added.

HSBC expects China's GDP to grow year-on-year by 8.5% in the second half of the year.