China Pares Lending Rates with New Benchmark, More Cuts to Come

Daniel Fowler
August 22, 2019

That's below the five-year benchmark lending rate of 4.90 per cent. Interest Rate in China averaged 4.70 percent from 2013 until 2019, reaching an all time high of 5.77 percent in April of 2014 and a record low of 4.25 percent in August of 2019.

The People's Bank of China (PBOC) debuted its new loan prime rates (LPR) under a new mechanism that was unveiled over the weekend. The LPR is the commercial banks loan rate providing to their best customers. It has stayed near 4.3% - nearly the same as the one-year benchmark lending rate of 4.35%. This will change the current system, in which the loan prime rate (LPR) remains somewhat separate from market forces. Tuesday's rates will be effective until the next release on September 20.

PBOC vice-governor Liu Guoqiang told reporters on Tuesday that there is room for cuts in both the banks' reserve requirement ratios (RRRs) and interest rates, but added the central bank's previous benchmark rate may not be changed in the near term.

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The new five-year LPR rate was set at 4.85 per cent, according to the PBOC's national interbank funding centre, which was below the five-year benchmark lending rate of 4.90 per cent.

All that said, the central bank wants to lower corporate borrowing costs without resorting to cutting its benchmark interest rates, which PBOC Governor Yi Gang described last month as being at an appropriate level. "A decline of only a few basis points is small and, unlike a benchmark lending rate cut, it will only feed through to borrowing costs on new loans, not outstanding ones". "By allowing the rate to float, they are basically allowing interest rates to fall".

To better reflect market changes, the central bank on Saturday released a plan to improve and reform the LPR mechanism in its latest move to guide borrowing costs lower to support the real economy.

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It was also meant to better reflect market demand for funds than the benchmark the PBOC sets.

"Overall, it is a modest cut in line with our expectations, though in the future, it's expected the LPR could go further lower, as China has its own target of steering funding costs lower", said Shen Xinfeng, an analyst with Northeast Securities. Lower interest rates would help private and small and medium sized enterprises obtain much needed funding.

Some analysts expect that the PBOC will "soon" cut the MLF rates as its next move to lower loan rates.

"The first rate came in higher than expected", Li Wei, China economist at Standard Chartered Bank, said, expecting LPRs to trend lower in coming months.

Economists expect that the reform will cut into commercial banks' lending margins.

Under the reforms, the LPR will broadly monitor modifications in the PBOC's medium-term lending services rates, making banks' lending rates more market-based.

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