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China's banks warned to be prudent in setting rates

BEIJING -- Chinese banks took control of setting loan interest rates on Saturday as the country's central bank warned them to be prudent and alert to credit risks.

The People's Bank of China (PBoC) announced Friday that it was lifting controls on loan interest rates effective Saturday, framing the move as a way to lower financing costs for businesses and support China's long-term economic restructuring.

In a statement on its website on Saturday, the central bank said that loan interest rates should be set “on the basis of market supply and demand,” while taking account of “credit risk”.

“Financial institutions must actively adapt to the market price-setting method” for fixing the rates, it said.

The central bank also told institutions to “construct improved pricing mechanisms,” raise levels of service, maintain normal lending and “strengthen interest rate risk management.”

Under the reform, the central bank removed a lower limit on lending rates, which had previously been set at 70 percent of its fixed benchmark rate.

But it said it would not adjust current restrictions on deposit and mortgage rates, the latter in order to promote “healthy development of the housing market.”

The move to give banks control of loan interest rates comes as growth in the world's second-largest economy has slowed this year, setting off alarm bells among analysts about prospects for the rest of 2013.

Gross domestic product expanded at 7.5 percent in the second quarter, down from 7.7 percent in the first quarter and 7.9 percent from the last quarter of 2012.

The figures this year have so far proved disappointing after the 7.8-percent growth seen in 2012 — itself the worst in 13 years.

Analysts described the measure as a positive and symbolic step toward liberalization of China's still highly controlled financial system.

“The government is signaling a commitment to letting market forces play a greater role in determining financial conditions,” economists at Capital Economics wrote in a report Friday.

“In the long-run this should encourage lenders to pay more attention to credit risks and improve the allocation of credit.”

Cao Yuanzheng, chief economist at the Bank of China, cautioned that banks need more time to gear up for any further freeing up of the system, such as the removal of a cap on deposit rates, the state-run China Daily newspaper reported Saturday.

“The liquidity crunch in the interbank market in June has shown that banks haven't equipped themselves with mature liquidity management,” Cao said, according to the newspaper.

“They are not ready for more substantial deregulation on interest rates.”

A cash crunch spooked Chinese financial markets late last month before the PBoC, which had ordered banks to strengthen liquidity management, moved to calm nerves with an offer of support.

The brief turmoil underscored rising concerns over excessive lending by banks and other weaknesses in China's financial system, including opaque non-bank forms of lending, often called “shadow finance.”

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