China introduces new reference rate for pricing bank loans

Last Friday (Aug. 16), the People’s Bank of China announced that commercial banks should price their new lending according to a “loan prime rate” (LPR) published by the National Interbank Funding Center (NIFC). The LPR is based on rate quotes by a panel of 18 banks offered to their most creditworthy customers. The LPR is published on the 20^th day of each month.

The new LPR is defined so that the panel banks announce their rates relative to the rate of central bank financing (primarily medium-term lending facility (MLF) rate). Panel banks’ quotes were previously linked to the PBoC’s benchmark rate.  Now the LPR can be more flexible fine-tuned to reflect changes in the monetary policy stance. The rate reform also includes quoting of a longer maturity (5 years and over) LPR.

Banks earlier based their loan pricing on the PBoC’s benchmark rates. The mechanism was unclear after the nominal deregulation of rates in 2015 that gave, in principle, commercial banks autonomy to price their loans. Introduction of the new reference rate is seen as further progress in deregulation of interest rates and a shift to more market-based pricing. An important motive is also the need to lower corporate borrowing costs in uncertain economic times.

The one-year LPR rate in August is 4.25 %, while the PBoC’s benchmark rate is 4.35 %. The five-year LPR is 4.85 %. According to some sources, most of the benefits of lower interest rates could go to large state-owned enterprises and loan prices for smaller firms may remain high even with the reform. The new reference rate will not have an immediate effect on corporate debt-servicing costs as most of current loans remain tied to the PBoC’s benchmark rate, which has remained unchanged since 2015. The dynamics of the new LPR have yet to be established.