China's central bank reforms rates to increase cheap business finance

BEIJING – China's central bank on Saturday unveiled a long-awaited reform of its interest rate mechanism, a move that would cut funding costs for businesses struggling with a cooling economy.

People's Bank of China said in a statement on Saturday it would replace the existing reference rate with the Loan Prime Rate, which is based on real rates in banks' lending rates, as a reference for banks in pricing new loans.

The move, which had been previewed in comments by the country's central bank and the government, would better reflect real market lending rates and allow lenders to respond quickly to the central bank's relief.

Politicians also hope to significantly reduce borrowing costs for China's smaller companies, which have been hit hardest by the economic downturn, but which have only limited access to cheap funding, as opposed to the larger state-owned peers.

Days earlier, China reported an increase in urban unemployment to its highest level ever, while industrial production slowed to its slowest pace in more than a decade. The central bank also reported a strong withdrawal of new loans last month as demand for credit declined.

At the same time, China's continuing trade war with the United States shows no signs of slowing, raising concerns about a further slowdown in the domestic economy.

Instead of reducing interest rates, which policy makers fear could have more capital outflow, Beijing has instead turned to a reform of the interest rate mechanism to lower real lending rates for borrowers.

While China's central bank had already spent large sums in the banking system this year in an attempt to lower its lending rates, liquidity was largely unable to get it to smaller borrowers because of banks' unwillingness to lend to private companies.

Under the new mechanism, banks will each month add to the central bank the price of loans offered to their best customers, which are tied to a medium-term PBOC-controlled lending facility.

The central bank will use the average price of the loans to derive LPR, the statement states. Previously, banks used benchmark rates to price LPR.

The central bank said it would release the first interest rate under the new mechanism on Tuesday and update the interest rate every month.

Chen Shujin,

an analyst with

Huatai Securities

said the change was likely to increase the efficiency of the central bank's monetary policy, but warned that this move alone would not solve all the financing problems faced by small businesses, which also struggle to access bank credit.

The Central Bank separately said that it would introduce a five-year LPR to serve as a reference for longer-term loans such as mortgage loans. The current LPR provides only one year interest rate.

Existing bank loans will not be affected by the new mechanism, reports the PBOC.

—Grace Zhu

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