China frees bank lending rates on reform agenda

China's central bank announced a key move Friday to liberalize bank lending rates, underlining the government's resolve to push market reform to revitalize the slowing economy.

The floor limit for lending interest rates will be canceled and financial institutions can decide their own rates following commercial principles, said a People's Bank of China (PBOC) statement.

Controls on bill discount rates will be scrapped and the ceiling limit for lending from rural banks will be eliminated. It did not remove the ceiling on deposit rates, and retained the lending interest rates for personal homes for the healthy growth of the property market.

Under the previous system, the PBOC set guidelines for lending and deposit rates for commercial banks which were willing to lend to state-backed firms with artificially high rates.

Banks are not allowed to lend at rates below 70 percent of the guideline rates. There are no ceilings for deposit rates.

LONG-AWAITED REFORM

The central bank's move marks a big step towards market economic reform and indicates the future path for reform, said Yu Yongding, an economist with the Chinese Academy of Social Sciences.

The move is a response to complaints from small and private businesses that have been marginalized by state-backed enterprises and banks due to their monopolistic advantages.

"Lifting controls on lending interest rates can help cut costs for enterprises in raising funds and it can also optimize financial resources to boost the real economy and economic restructuring," the PBOC statement said.

"Cutting controls on the rates will allow cash-thirsty business, especially private enterprises to have easier access to loans," said Yu Yongding, adding that the move will also help curb speculative trading to some extent.

Private and small business play a critical role of stabilizing China's economy and social stability, as they turn out 90 percent of GDP and 80 percent of jobs. Marginalizing them harms growth momentum.

Henry Cai, executive chairman of corporate finance of Deutsche Bank's Asia Pacific region, said the marketization of interest rates will benefit the real economy, with needy enterprises getting cheaper loans and banks being refrained from earning monopolistic profits.

"It is the real economy, other than banks, that is short of money," he said.

The Chinese government is determined to regenerate its outdated economic system, with marketization of interest rates high on the reform agenda.

Last June and July, the central bank widened the floating bands for lending and deposit rates.

In the second quarter of 2013, the Chinese economy grew 7.5 percent year on year, down from 7.7 percent in the first quarter, as the government deliberately cooled down the growth in exchange for space for rebalancing the economy to allow for more sustainable expansion.

"From the macro perspective, the economy runs steadily and consumer prices remain stable, which means it's good timing for reform," according to the PBOC statement.

CAUTIONS REMAIN

Scrapping the controls is an important step toward interest rate marketization. However, it is insufficient, as the ceiling limit for deposit interest rates remains unchanged, said Zuo Xiaolei, chief economist at China Galaxy Securities.

The central bank keeps the 110 percent ceiling of guideline rates for deposits which have long been complained for eating up household saving values and refraining China from developing into a consumption-fueled economy.

"Keeping the ceiling for deposit rates is in consideration of lending rates' more profound impact [on the economy] which needs more mature conditions," the central bank statement said.

Globally, liberalizing the lending rates is the most critical and risky part of interest rate market reform. It will be carried out gradually and orderly, the statement said.

In June, the PBOC said the long-awaited deposit insurance system is ready to be launched. The system will help "increase the flexibility of commercial banks in terms of financial business innovation and risk control, and is believed as an essential tool to cushion the shock of reform to the banking system.

Deposit insurance programs protect bank depositors by guaranteeing that a certain level of deposits can be paid, even if a commercial bank goes bankrupt and cannot pay them.

"The central bank will work with other departments to improve the fundamental conditions to liberalize deposit rates steadily and orderly," according to the statement.