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China’s central bank said it’ll start releasing a new reference rate for bank loans, a further step in a long-awaited reform to interest rates that’s set to bring lower borrowing costs to the economy.
The People’s Bank of China will announce the new loan prime rate, or LPR, at 9:30 a.m. on the 20th of each month, starting this month, according to a statement on Saturday. The central bank will require commercial lenders to set the price for new loans to businesses and households “mainly” with reference to the LPR, while the price for outstanding loans can stay unchanged for now, it said.
The use of the new reference rate signals policy makers are completing the last mile of an overhaul to the country’s rates system, which still bears some hallmarks of the Communist command system. If successful, the revamp can stimulate demand for new credit and aid growth in the world’s second-largest economy as it remains embroiled in a protracted trade war with the U.S.
Why China’s Getting Ready to Shake Up Interest Rates: QuickTake
The central bank said Saturday that commercial lenders submitting prices for the calculation of the new LPR will report in terms of a spread on top of the interest rate of the PBOC’s medium-term lending operations, currently at 3.3%. As the current benchmark 1-year lending rate stands at 4.35%, new loans priced from the LPR could carry a significant discount.
The reform of the LPR can “achieve the effect of lowering the real interest rate for loans,” the central bank said.
The reform will make the “overall lending rate for the real economy move downward, which will achieve an effect similar to that of cutting interest rates,” Li Qilin, chief economist at Lianxun Securities Co., wrote in a note. Its effectiveness can only be seen in the pricing on Tuesday, he said.
The number of banks participating in the pricing will be increased to 18 from 10, with the types of lenders expanded to include city and rural commercial lenders, foreign lenders with operations in China, and privately-owned lenders, the central bank said.
China’s economy weakened more than expected in July after a brief bounce in the previous month, and the effects of the trade war with the U.S. are expanding into finance and the currency. While the PBOC has been providing liquidity to the banking system to reduce interbank borrowing costs, the easing has only passed through into the real economy to a limited extent.
A key reason preventing the effective transmission of cheaper market rates to the economy is that banks set the price of loans with reference to the old benchmark lending rates, the PBOC said. Some banks have even taken concerted actions to “set a hidden floor” for loan prices, it said.
More details about the new LPR:
18 reporting banks will add a few basis points on the MLF interest rate based on their own funding costs, market demand and risk premiumBanks will submit prices before 9 a.m. on the 20th of each month to the National Interbank Funding Center, which will leave out the highest and lowest values and then calculate the arithmetic mean of the remaining 16 to form the LPR. That will be released at 9:30 a.m. of the same dayThe LPR will be released once a month, rather than the current practice of reporting daily, in a bid to improve the quality of the pricingThe LPR will cover more maturities, including tenors longer than five years, in addition to the current one-year tenor. The LPR with longer-tenor can help banks set the price for long-term loans such as mortgagesWhile the LPR only references new loans for now, it will be used for outstanding long-term loans in the futureEnterprises can report to regulators if banks keep a “hidden floor” for loan rates, and the PBOC will include the use of the LPR into its macro-prudential framework and its quarterly regulatory checks with commercial banks
Initiating the interest-rate reform to lower borrowing costs for the economy, rather than cutting existing interest rates straight away, signals a continuation of China’s targeted approach to easing. The PBOC called for a “rational” view on current headwinds in a key policy report earlier this month, signaling that large-scale stimulus isn’t the first option as it tries to fend off rapid debt growth and asset bubbles.
The changes will eventually enable the PBOC to influence the entire economy and financial markets via the price of its short-term loans in the open market, similar to other major central banks.
Most central banks govern the price of money in an economy via the rate which banks are charged to borrow cash over short periods. In China, that approach has long divided into two steps. Currently, the PBOC sets a rate that prices mortgages, business loans and other commercial lending -- the one-year lending rate. Separately, the 7-day reverse repo rate is considered the benchmark for short-term inter-bank borrowing.
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