China Starts Prime Loan Rate as New Benchmark in Market Push

China started publishing a new lending rate based on quotes from banks and signaled it may eventually replace the current benchmark set by the People’s Bank of China, deepening a shift to market-based interest rates.

China’s interbank funding center, under the PBOC, will calculate a weighted average “loan prime rate” each day from costs charged to the best clients by nine major lenders including Industrial & Commercial Bank of China Ltd., the Beijing-based central bank said in a statement today. The one-year rate is 5.71 percent today, compared with the PBOC-set benchmark of 6 percent.

The state-set lending rate is losing relevance after authorities in July removed the lower limit on borrowing costs, giving banks more freedom to set their own rates. The government is likely to loosen more controls in financial markets over the next year as Communist Party leaders meet in November to discuss economic reforms, a Bloomberg News survey showed this month.

“It’s a positive move in rate liberalization,” said Xu Gao, chief economist with Everbright Securities Co. in Beijing, who previously worked for the World Bank. “The new rate can be a very useful indicator for economists and analysts to measure credit demand and supply on the ground -- a good indicator that did not exist before.”

Xu said more time is needed to see whether the new rate is “truly determined by the market,” citing the daily yuan fixing that’s supposed to be based on banks’ quotes “but everyone knows it’s decided by the central bank.”

Biggest Lenders

The nine banks included in the rate are China’s largest commercial lenders by assets and are all government-backed. The other eight banks in the survey are China Construction Bank Corp., Agricultural Bank of China Ltd., Bank of China Ltd., Bank of Communications Co., China Citic Bank Corp., Shanghai Pudong Development Bank, Industrial Bank Co. and China Merchants Bank Co.

Song Guoqing, an academic member of the PBOC’s monetary policy advisory committee, said earlier this week that China’s benchmark interest rates can’t accurately reflect changing market rates.

The new rate “will promote a smooth transition for the pricing benchmark from being determined by the central bank to being decided by the market,” the PBOC said. The loan prime rate, or LPR, will co-exist with the existing benchmark lending rate for a “certain period of time,” the PBOC said without elaborating.

Improve System

China is starting the LPR to “promote interest rate liberalization, improve the benchmark-rate system in the financial markets and guide credit-product pricing,” the central bank said.

Today’s action follows news yesterday that the PBOC and U.S. Federal Deposit Insurance Corp. signed an agreement to strengthen communication and policy coordination. The PBOC signaled in July it would eventually free up rates on savings, which are still capped, as authorities develop a deposit-insurance system.

For now, the central bank can raise or lower deposit rates to adjust monetary policy, and in the long run, the Shanghai Interbank Offered Rate, or Shibor, should be developed as a benchmark, Everbright’s Xu said.

“The role of Shibor is still not effective enough to influence rates between banks and their clients,” Xu said.

— With assistance by Xin Zhou

Before it's here, it's on the Bloomberg Terminal.