China abolishes banks’ floor lending rates

Critics say move not a breakthrough in rate liberalization.

China scrapped the lower limit on bank lending rates on July 19 in a move seen by some as a major step toward liberalizing interest rates but criticized by others. The decision was also aimed at cutting financing costs for businesses amid a worsening slowdown in China’s economy.

The People's Bank of China, the central bank, also scrapped the upper limit on lending rates among rural credit cooperatives while leaving a floating range on individual property lending rates untouched to secure healthy development of the real estate market.

It said the lower limit on commercial banks' lending interest rates will be removed starting July 20. This means China has now ended controls on lending rates.

Previously, banks were allowed to extend loans at rates higher than 70% of the benchmark lending rate set by PBOC, which has been held at 6% since the last reduction in July 2012.

PBOC said financial institutions will now determine the prices for loans by themselves according to commercial principles.

"After the limits on lending rates are called off ... the negotiating space between financial institutions and clients will be broadened, which will facilitate a decline in enterprises' funding costs as lenders adopt a differentiated pricing strategy."

PBOC now expects financial resources will be channeled to support the real economy and better serve economic restructuring and upgrading.

Analysts see the surprise move as a signal that China is firmly pushing forward deregulation and will let market forces play a bigger role in allocating financial resources.

Other analysts, however, said that since only a very small proportion of bank loans are priced at 70% of benchmark rates, it is hard to say if the new move will result in lower loan prices.

They said the move cannot be considered a breakthrough in rate liberalization as long as the limits on deposit rates are not touched, and since 90% of bank loans in the first quarter were priced higher than the benchmark rates.

They said the key to interest rate reform still lies in loosening the upper limit on deposit rates.

The move, however, can be viewed as a stimulus to the real economy since state-owned companies will face a lower effective borrowing rate.

It would also help the economy pick up somewhat late in the third quarter and in the fourth quarter.