China Removes Floor on Lending Rates as Economy Slows

China eliminated the lower limit on lending rates offered by the nation’s financial institutions as economic growth slows and Premier Li Keqiang expands the role of markets in the world’s second-biggest economy.

The change, effective yesterday, removes a floor set at 30 percent below the current 6 percent benchmark, giving banks freedom to set their own lending rates. The People’s Bank of China made the announcement on July 19.

The shift, which came as central bankers and finance ministers from Group of 20 nations gathered in Moscow, follows renewed calls by the International Monetary Fund for China to boost financial sector reform to help contain risks. 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.

“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.”

China is not yet ready for freeing up deposit rates, the “most risky” part of interest-rate liberalization, the PBOC said, adding that the nation lacks a deposit insurance system.

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

No Consensus

There’s no consensus on deposit-rate reform, Song Guoqing, an academic adviser to the central bank, said yesterday.

“Some people said the timing is right, others said it’s not, there is no unified view,” Song told reporters at a conference in Beijing. “Had there been a unified view, it would have been announced” on July 19, he said.

The lending-rate change will probably weigh on shares of Chinese lenders this week, according to Macquarie Capital Securities Ltd.

“Sentiment wise this is definitely bad for China banks, as many will comment that banks’ net interest margin will be under further pressure," Victor Wang, a Hong Kong-based analyst at Macquarie, said in an e-mail. ‘‘In theory, large banks with higher exposure to large corporate lending have more to lose and are therefore more exposed.’’

China Construction Bank Corp. and Bank of Communications Co. are the two ‘‘worst positioned,’’ Wang said.

Exacerbate Concerns

Chinese banks’ valuations are already close to their lowest on record as a cash crunch in the interbank market exacerbated investors’ concerns that earnings growth will stall and defaults may surge as the economy slows.

The MSCI World Index of stocks reversed losses immediately after the PBOC’s announcement. It gained 0.2 percent as of market close in New York on July 19. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. climbed less than 0.1 percent for a second weekly rally.

China’s economy grew 7.5 percent in the second quarter from a year earlier, down from 7.7 percent in the first three months, and is at risk of the weakest expansion in 23 years. Song estimates growth may slow to 7.4 percent in the July-September period, the third straight quarterly deceleration.

The central bank’s move showed the leadership may be ‘‘a bit worried about growth,” Song said, adding that he was giving his personal view. While the government may fine-tune policies, there won’t be a big stimulus, he said.

‘Full Confidence’

The government has “full confidence” it will reach its 2013 growth target of 7.5 percent, Zhu Guangyao, a vice finance minister, said yesterday. The PBOC’s action was “just one element” of a master plan of the new Chinese leadership encompassing monetary, market and fiscal policies, Zhu said in an interview at the G-20 meeting in Moscow.

The removal of the lending floor builds on the leadership’s pledges to expand an overhaul of interest rates, tagged by the World Bank and the IMF as a priority in financial reform.

In its annual assessment of China’s economy published last week, the IMF said China must move to use interest rates as the primary tool of monetary policy and allow banks to price deposits and loans according to market principles.

China’s one-year benchmark lending rate has been held at 6 percent since the last reduction in July 2012. The PBOC last year allowed banks to offer rates as much as 10 percent above the benchmark set for deposits and let financial institutions offer loans at a discount of 30 percent below the benchmark lending rate.

Not Same

“This is not the same as a rate cut and the impact will be very limited,” said Helen Qiao, chief Greater China economist at Morgan Stanley in Hong Kong. “Liquidity conditions are very tight -- we weren’t seeing companies getting funding at anything close to the lower band before this change, so we’re unlikely to see this will induce an immediate drop in rates. Lending costs come down only when funding becomes abundant.”

In the first quarter, only about 11 percent of loans were priced below the lending benchmark, central bank data show.

China will maintain the floor for mortgage rates because the government will continue to curb speculative home buying and investment, the PBOC said. It will remove the cap on lending rates offered by rural cooperatives and also scrap controls on bill discount rates.

PBOC Governor Zhou Xiaochuan, who was reappointed in March after a record tenure of 10 years in the job, said in November that changes to the interest-rate system should be made at a “moderate” pace.