China makes borrowing costs a tiny bit cheaper for companies

The revamped market benchmark rate is part of China’s plan to connect its interest-rates system to conditions in financial markets.

SHANGHAI: Loans will get a little cheaper for Chinese companies after officials introduced a revamped market benchmark rate for the first time.

China’s new one-year reference rate for bank loans will start at 4.25%, according to a statement from the central bank on Tuesday.

That compares to the 4.24% median estimate in a Bloomberg survey of 11 traders and analysts.

The previous loan prime rate was 4.31%, while the one-year benchmark lending rate is 4.35%.

China will set the LPR on the 20th day of every month.

The change is part of China’s push to connect its interest-rates system to conditions in financial markets.

The aim is to help lower the country’s sticky borrowing costs for households and companies, boost lending activity and support a slowing economy.

From Tuesday, new loans must be priced “mainly” with reference to the new LPR, which is linked to the price the People’s Bank of China charges lenders for cash over a year.

The reform is to “repair the channels” to make policy more effective, but it “can’t replace monetary policy or other policies,” the PBOC said in a statement provided at a briefing Tuesday.

The bank said it would continue to work with other government ministries to use various measures to lower borrowing costs for the real economy.

“That is a very timid cut, well within market expectations,” said Asia Westpac Banking head Frances Cheung.

“If the PBOC adjusts open-market operation rates, in particular the MLF rates, the transmission will be more effective.”

The new approach will see net interest margins and bank profits hurt in the short-term, Liu Guoqiang, a deputy governor at the central bank, said Tuesday.

As well as a likely hit to lenders’ margins, it will push them to increase their risk tolerance when it comes to underwriting loans, according to Moody’s Investors Services.

Bonds were little changed after the announcement, with the yield on 10-year government debt rising 1 basis point to 3.03% as of 1:27pm local time.

Some expect the central bank will do more this year to lower borrowing costs.

Citic Securities analysts predict a cut in the rates charged on medium-term lending facilities, or a targeted reduction in the reserve-requirement ratio, according to a note.

Westpac’s Cheung is predicting two 50 basis-point cuts this year in the amount of cash that banks have to hold in reserve.

She also expects a 5-10 basis point cut in the 1-year MLF rate.

Some 590 billion yuan (US$84 billion) of MLF will mature by the end of September, Bloomberg-compiled data show.

Officials are probably aiming for a gradual shift in lending rates, as a drastic cut could be damaging to the financial sector, according to Tommy Xie, an economist at Oversea-Chinese Banking.

Bank stocks opened lower Monday as analysts predicted lower rates will make lending less profitable.

“As this is a long-term structural change, it’s not necessary to change the loan prime rate dramatically in the near term,” said Xie.

“In the end, banks will also try to protect their margins. If the cut is too aggressive, they will pay the cost.”

With new loan allocation front-loaded this year, most of the impact on net interest margins will surface in 2020, according to Citigroup. analysts.

Assuming LPR is 25 basis points lower, it will cut net profits at the banks by about 3.7%, they said, adding that Ping An Bank and China Everbright Bank will be among the most affected.

The PBOC said in a statement over the weekend that the 18 banks helping set the new rate should submit quotations in multiples of 5 basis points.

The National Interbank Funding Centre will cut the highest and the lowest and use the mean of the remaining 16.

“There is little evidence so far that LPR, since it came into being in 2013, followed short-term market rates, especially 7-day repo rates, closely,” Bank of America economists Helen Qiao and Miao Ouyang wrote in a note.

“Our concern is that the new measures promoting LPR could risk giving rise to a third track in addition to the existing two.”