PBoC removes lending rate floor

The People's Bank of China today announced it will from tomorrow no longer put a floor under bank lending rates in the country – allowing banks to compete for borrowers by pricing loans at less than 70% of the PBoC's benchmark rate.

The announcement also says the ceiling on lending rates offered by rural credit co-operatives will also be removed. It previously stood at 2.3 times the benchmark rate. However, the PBoC did not remove the deposit rate cap, currently 10% above the benchmark rate, which it says will be "the most critical and risky step in interest rate liberalisation".

Today's removal of the lending rate floor will in practice have little effect, according to Capital Economics' chief Asia economist Mark Williams, who points out that only 11% of bank loans to corporates in Q1 2013 were priced below the benchmark rate, and that in any case the "rapid growth of the corporate bond market has provided an alternative source of credit for larger firms in recent years".

Nonetheless, Williams says, "this is a significant development for China's financial sector", in that it signals "a commitment to letting market forces play a greater role in determining financial conditions. In the long run, this should encourage lenders to pay more attention to credit risks and improve the allocation of credit," he says.

Williams says the "key next step" will be the removal of the deposit rate cap, which the PBoC says will only happen once a deposit insurance scheme is in place. Williams says he expects such a scheme to be introduced later this year.

Today's moves, he says, "do not add up to a loosening of monetary policy" given that the average lending rate has long been well above the benchmark rate, with loans limited "by quota and other quantitative means and channelled to the best-connected firms (typically state-owned) rather than those best able to generate returns".