China removes floor on lending rates amid economic slowdown

China will remove the floor on lending rates offered by the nation’s financial institutions as economic growth slows and authorities push forward steps to give banks more freedom to set borrowing costs.

The change, effective tomorrow, eliminates a limit set at 30% below the current 6% benchmark, according to a People’s Bank of China statement today. The central bank left a deposit-rate cap unchanged.

While the move temporarily jolted world stocks higher, the PBOC acknowledged that it was a limited step and said that freeing up deposit rates would be more important. The shift came as central bankers and finance ministers from Group of 20 nations gather in Moscow and after a cash squeeze in money markets curbed a record expansion in China’s credit.

“While deposit-rate liberalization is still possible, the fact that a decision was made to just remove the lending-rate floor suggests that more aggressive liberalization proposals were defeated, or at least delayed,” said Ken Peng, senior economist at BNP Paribas SA in Beijing. “This decision shows that some reform is being done, but may actually reduce the chances for deposit-rate liberalization in the near term.”

Raising the deposit-rate ceiling would improve household incomes and reduce the attractiveness of non-traditional wealth management products while threatening banks’ profit margins, Peng said.

Funding Costs

Today’s move will lower companies’ funding costs and boost financial institutions’ pricing capabilities, the PBOC said. In March, only 11% of loans were priced below the lending benchmark, according to central bank data.

The MSCI World Index of stocks reversed losses after the announcement, then fell and was down 0.1% as of 9:02 a.m. New York time.

The nation’s economy grew 7.5% in the second quarter from a year earlier and is at risk of the weakest expansion in 23 years. Today’s announcement builds on pledges by Premier Li Keqiang to expand an overhaul of interest rates, tagged by the World Bank and the International Monetary Fund as a priority in financial reform.

Lu Ting, head of Greater China economics at Bank of America Corp. in Hong Kong, said that today’s announcement seemed a “token” move after the interbank liquidity squeeze in June and “a real move” will involve deposit rates.

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