| HONG KONG, July 21
HONG KONG, July 21 China's decision last week to
liberalise bank lending rates, though widely applauded, has
raised suspicions that it reflects official concerns over
possible loan defaults and is aimed at helping out heavily
indebted state firms and local governments.
China's central bank announced on Friday that banks could
now lend at whatever rate they liked, enabling them to compete
for new borrowers with cheaper credit at a time when the world's
second-largest economy is slowing markedly.
But some investors said the move was symbolic and likely
represented, in the short term at least, relief for heavily
indebted state-owned enterprises (SOEs), big private-sector
employers and local government financing arms.
"I'm a little sceptical of the appraisals that this is a
big, big reform move," said Patrick Chovanec, managing director
and chief strategist at Silvercrest Asset Management in New York
and formerly a professor at Beijing's Tsinghua University.
"My concern in the short run is that what will happen is
that a bunch of local government financing vehicles will get
lower interest rates," he added.
The announcement by the People's Bank of China (PBOC) was
welcomed by economists and came as G20 finance ministers and
central bankers met in Moscow, where Japanese Finance Minister
Taro Aso described it as a step in the right direction.
"We see today's announcement as a signal of the PBOC and the
new leaders' commitment towards interest rate liberalization and
more market-oriented reform," wrote Jian Chang and Joey Chew,
economists at Barclays, in a note to clients.
However, they and other economists said that, with China's
growth slowing, the banks -- including major lenders such as
Industrial and Commercial Bank of China Ltd, China
Construction Bank Corp, Bank of China Ltd
and Agricultural Bank of China Ltd --
were unlikely to take advantage of the opportunity.
As it is, only about 11 percent of loans extended by China's
biggest banks are below the just-scrapped 6 percent official
rate, despite having had some leeway to stray from it. Most are
in fact priced well above that.
Instead, economists say, the PBOC's move signals Beijing's
determination to forge ahead with capital markets reform to
remove the conditions that helped fuel China's property-led
In the short term, though, international bankers and
investors active in China say the timing of the reform - coming
roughly a month after the PBOC cracked down on lending in the
shadow banking sector - may be less about banks issuing new
loans than about keeping old loans from going into default.
"They're getting very concerned about the slowdown and the
potential for non-performance or defaults," said a senior
European banker in Singapore, who asked not to be named to avoid
jeopardizing the bank's relationship with Beijing.
"The only firms that would get any kind of break are the
preferred SOEs already getting discounted loans."
Foreign bankers and investors draw parallels with Japan in
the 1990s when banks avoided restructuring loans to their
biggest borrowers and refinanced them at lower rates -- an
"extend and pretend" policy that helped create so-called zombie
companies and was blamed for Japan's two decades of economic
Few question the need for China to liberalise interest
rates. Until Friday, commercial banks were allowed to lend at
rates no lower than 70 percent of the government benchmark of 6
percent, or roughly 4.2 percent. At the same time, the rate
banks could pay depositors was capped at 110 percent of another
benchmark rate of 3 percent, or about 3.3 percent.
The result was that banks were virtually guaranteed a 0.9
percentage point profit margin on every loan. Though designed to
ensure the health of lenders, the policy fuelled unsound
lending. To maximise profitability of a fixed margin, banks lent
primarily to only the lowest-risk borrowers -- big
state-connected companies. And with rates below the rate of
inflation, depositors looked for better returns on investments
That has produced over-lending by banks to big companies and
an explosion of unregulated non-bank lending to small and
medium-sized firms. Standard & Poor's estimates China's shadow
banking sector grew into a $3.7 trillion business last year.
Big companies stacked with cheap credit have begun
re-lending those funds as well. Their issuance of so-called
entrusted loans and bankers' acceptance notes more than doubled
in the first four months of this year to 1.6 trillion yuan ($260
billion). If their borrowers default, they could in turn default
on what banks have considered the country's safest loans.
This ballooning credit has created what economists and the
International Monetary Fund see as unsustainable over-investment
in property, infrastructure and industrial capacity. The IMF
said in its latest annual consultation on China that the country
needed to push through reforms to make growth more sustainable,
rein in credit growth and liberalise interest rates.
The next, more difficult step to open banking to competition
would be to remove caps on deposit rates, a move economists say
would prompt lenders to allocate capital more efficiently,
helping rebalance the economy toward less wasteful investments.
Beijing has signalled its intention to make the necessary
reforms, even as it has cut its target for economic growth this
year to 7.5 percent from 8 percent, which would mark the
economy's slowest pace in 23 years.
China's challenge then, said Paul Gruenwald, chief economist
at Standard & Poor's in Singapore, is to pull off what neither
Japan, South Korea, Chile nor the United States, to name just a
few, have failed to do: deflate a credit bubble and reform the
economy without triggering a financial crisis.