OREANDA-NEWS. August 01, 2013. Approved by the State Council, the PBC has decided to remove controls on the lending interest rates offered by financial institutions to their clients effective from 20 July 2013. A PBC official answered questions on furthering market-based interest rate reform in an interview.

Q: What is the background of this round of furthering market-based interest rate reform?

A: China’s market-based interest rate reform has made headway since 1996 in accordance with the overall arrangements of the State Council. Before the announcement of this round of reform measures, the PBC only controlled the ceiling of deposit interest rates and the floor of lending interest rates. Interest rates on the money and bond markets and those of foreign currency denominated deposit and lending rates are all market determined. In June and July 2012, the PBC enlarged the floating range of the deposit and lending rates of financial institutions. Significant progress has been made in the market-based interest rate reform with rate pricing getting more and more differentiated across and within financial institutions. The market mechanism is playing an increasingly stronger role.

Overall speaking, the macro and micro-economic conditions are available for the furthering of the market-based interest rate reform. At the macro level, the stable economic performance and stability in the overall price level present a good time window for furthering the reform. At the micro level, along with the progress of financial sector reform, financial institutions have strengthened the hard constraints on their fiscal standing and developed independent pricing capability while the corporate and household sectors have adapted to a more market-based financial environment. Looking at the marketplace, the Shibor has become an important benchmark rate for pricing enterprise bonds, derivatives and other financial products and services as a result of development in many years. In terms of the monetary policy framework, the transmission of monetary policy to various kinds of financial products has been fairly smooth. Based on the decisions adopted at the 18th National Congress of the CPC and the 15th Five-Year Plan and in accordance with the overall arrangements of the State Council for financial sector reform, the PBC has, with the approval of the State Council, decided to further the market-based interest rate reform after a comprehensive evaluation of the various basic conditions and under the precondition of controlling risks.

Q: What is the significance of this round of reform measures of removing all the controls on lending interest rates?

A: After the controls on lending interest rates are removed, the financial institutions will have more discretion to negotiate with clients on deciding interest rates. On the one hand, this will promote a differentiated pricing strategy to be adopted by the financial institutions that will help reduce financing cost of the corporate sector, and encourage the financial institutions to improve independent pricing capacity, transform their operational model, improve services and step up financial support to the corporate and household sectors. On the other hand, this will prompt enterprises to choose from a multiple of financing channels based on their own circumstances. As enterprises seek direct financing by issuing bond or stocks, this will expand the direct financing market and promote diversified financing arrangements. Furthermore, the financial institutions will have more room to increase lending to micro- and small enterprises, increasing the credit availability to these enterprises. In general, this reform, as an important step in advancing the fundamental role of markets in resource allocation, is of great significance to encourage the financial sector to support the real economy, to adjust and upgrade the economic structure.

Q: Why is the floor of mortgage lending interest rates maintained in this reform?

A: In order to implement the real estate austerity policy of the State Council, curb the investment and speculative demand, and promote sound development of the real estate market, the PBC provides effective policy guidance and exercise prudential regulation over the mortgage lending and requests the commercial banks to continue the differentiated mortgage credit policies. Therefore, in this round of reform, the existing commercial mortgage lending interest rate policy remains unchanged and the floor is kept at 70 percent of the benchmark lending rates.

Q: Why is the ceiling of rural credit cooperatives (RCCs) lending rates removed?

A: In October 2004, when the ceiling of lending rates of financial institutions was removed, the lending rate ceiling of RCCs was kept due to the fact that their loan pricing mechanisms were yet to be improved. At that time, the control over their lending rate ceiling was maintained but the ceiling was adjusted from 200 percent of the benchmark lending rates to 230 percent. In recent years, thanks to the concerted efforts of relevant government departments, important progress has been made in the reform of RCCs. City credit cooperatives were either resolved or merged with city commercial banks. Township and village banks and other new types of rural financial institutions have developed rapidly. The reform of Rural Financial Service Division of the Agricultural Bank of China has been advanced steadily. With the improvement of rural financial services, the conditions have by and large matured for the removal of RCCs’ lending rate ceiling. As for the external environment, with the exception of the RCCs, the lending rate ceiling has been removed for all kinds of financial institutions that serve the rural customers. A mechanism is in place to determine the lending interest rates on a competitive basis. Internally speaking, the RCCs, as a result of their reform, have gradually strengthened internal control and governance, built risk management capacities, and improved loan pricing mechanisms. Their pricing behaviors have become more and more rational. As a matter of fact, their lending interest rates rarely reach the ceiling. Therefore, after the removal of RCCs’ lending rate ceiling, the funding cost for rural and agricultural borrowers will not rise by a large margin.

The RCCs play a major role in financial services to rural customers. The removal of their lending rate ceiling will encourage them to price loans independently in the principle of having returns covering risks, increase their willingness to lend to rural customers, build their capacities to meet diversified borrowing demand of rural and agricultural sector clients, improve the availability of fund for lending to rural and agricultural sector clients, facilitate the convergence of lending interest rate policy of various kinds of financial institutions, create a good institutional environment for fair competition, help enhance the leverage role of prices, and optimize the allocation efficiency of rural and agricultural supporting fund. All in all, this measure is of great significance to improve the financial services in rural areas.

Q: What is the PBC’s consideration for the next step measures of market-based interest rate reform?

A: This time, the floating range of the deposit interest rates is not further enlarged due to the consideration that market-based deposit interest rate reform has even more far-reaching impacts and needs more sophisticated conditions. Looking at the successful cases in other countries, removal of controls over deposit interest rates is the most critical and risky stage in the process of market-based interest rate reform and should be advanced in a progressive manner based on the availability of the various basic conditions. Since 2003, financial institutions have made major progress in their corporate governance reform and the reform is not completed. Meanwhile, other supporting schemes such as the deposit insurance scheme and the financial market exit scheme are being established. The PBC will work together with relevant authorities to improve the basic conditions for market-based deposit interest rate reform and advance the reform prudently and progressively.

Going forward, the PBC will further improve the market-based interest rate mechanism, optimize the financial market benchmark rate system, improve the mechanism for the financial institutions to independently price their products, gradually increase the liability products that are market priced, and allow market mechanism to play a fundamental role in the allocation of financial resources.