PBOC to cut borrowing costs with revamped rate system

Bloomberg

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, (LPR), at 9:30 am on the 20th of every month, starting this month, according to a statement. 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 US.
The central bank said that commercial lenders submitting prices for the calculation of the new LPR will report in terms of basis points added to the interest rate of the PBOC’s medium-term lending operations, the most recent of which was at 3.3%. 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, it said.
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 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.
China’s economy weakened more than expected in July after a brief bounce in the previous month, and the trade war with the US is expanding into financial and currency areas. 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.
The reform of the LPR can “achieve the effect of lowering the real interest rate for loans,” the central bank said.
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.