OREANDA-NEWS. March 25, 2015. The cost of short-term loans for Chinese banks has moved sharply down over the past week, as direct guidance from the central bank finally showed signs of gaining traction in money markets, although the cost of longer term debt has risen slightly since early March.

Despite two interest rate cuts to the benchmark one-year loan rate since November 2014, short-term borrowing costs for financial institutions have been rising steadily since the fourth quarter, while the crackdown on shadow finance beginning last year has pushed up costs for firms without access to formal bank credit.

Elevated interbank rates paired with falling central bank mandated commercial loan rates squeezes banks' margins and can make them more wary of lending.

Analysts said resistance to lowering short term loan rates stemmed from a combination of rising demand for short-term credit from stock speculators, a drain on yuan liquidity caused by a strengthening U.S. dollar, and general wariness over creditworthiness in the financial sector.

The downward move in interbank rates follows three cuts to the central bank's guidance rate for the benchmark seven-day repurchase (repo) agreement, considered the best indicator of market liquidity in the world's second-largest economy, this month.

On Tuesday, the Chinese central bank adjusted its guidance for the seven-day repo down another ten basis points to 3.55 percent, following a previous ten basis point cut on March 17th. At midday today the volume weighted average yield for the benchmark seven-day repurchase (repo) agreement was trading at 3.95 percent, its lowest since late January.

Falling rates in the interbank market could indicate that the real cost of borrowing in China, which has remained stubbornly high for many borrowers despite a series of easing measures beginning late last year, will finally begin coming down, but that will only be demonstrated when the cost of longer term credit used for business investment substantially eases.

Average interest costs on new loans for firms surveyed by China Beige Book, an independent data aggregator, found that real interest costs in Q1 2014 were 7.33 percent, up 39 basis points year-on-year and 198 basis points above the one year policy rate of 5.35 percent.

By mid-March the volume weighted average of the seven-day interbank repo rate had been above its 200 day moving average for over three months - the longest period since 2011.

Another factor pushing up interbank rates has may have been the crackdown on lending and borrowing by non-bank local government financing vehicles (LGFVs).

Interbank rates spiked in December following the China Securities Regulatory Commission's announcement that AA grade corporate bonds - the rating carried by many LGFVs - could no longer be used as collateral for repo transactions, and began drifting downwards in the second week of March, following the Ministry of Finance's announcement that a significant portion of LGFV debt could be "converted" into lower interest official provincial or municipal debt.