China’s interest rate reform has taken another step forward. Through the new loan interest rate pricing mechanism, China hopes to reduce the financing costs for enterprises. In fact, in the short term, this mechanism may not be able to provide enough intermediate for companies of most urgent loan funding. As a result, reform requires a series of supporting policies.
The People’s Bank of China improved the loan benchmark rate – Loan Prime Rate (LPR). LPR is not new, which was established in 2013. This reform will replace the loan benchmark interest rate with LPR as a reference indicator for bank loan interest rates. LPR will be quoted by 18 banks on the 20th of each month. LPR will refer to the central bank’s medium-term credit facility interest rate MLF, plus the spread. On August 20, 2019, the 1-year LPR was 4.25%, a slight decrease from the previous 4.31%.
Reform is not enough for current problems
As we all know, China’s small and micro enterprises are facing difficulties in lending, and loan resources are concentrated in state-owned and large enterprises. Although market-oriented reforms are conducive to the rational allocation of resources, banks will still tend to operate steadily and avoid issuing high-risk loans in the environment of a downturn in the economy. In addition, banks still need to refer to the central bank’s signals to set spreads, limiting the role of the market to form a price mechanism. Finally, LPR only applies to new loans, while existing loans still refer to the old loan benchmark interest rate.
Supporting policies are essential
If China needs to follow the path of global central bank interest rate cuts and reduce the financing costs of enterprises, it will also need a series of supporting facilities in addition to reforms. Since the existing loans are still referenced to the benchmark interest rate of the loan, only a reduction in the benchmark interest rate can achieve a full rate cut. In addition, the central bank needs to increase long-term funding. Guide the bank to carry out medium and long-term loans by conditionally reducing the deposit reserve. Finally, since LPR will refer to the medium-term credit facility MLF interest rate. By lowering the MLF rate, banks can receive a clearer monetary policy.
In summary, interest rate reforms can be a hint for interest rate cuts of new loans. In the coming months, the People’s Bank of China can implement a loose monetary policy through MLF interest rates, pushing down the yield of China’s onshore bonds in various tenors.