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20/08/2019 14:20

LPR reform credit negative for Chinese banks' profitability

[ET Net News Agency, 20 August 2019] On 17 August, the People's Bank of China (PBOC),
the central bank, announced reforms to the loan prime rate (LPR) mechanism. Beginning on
20 August, the new LPR will average the lending rate quoted by 18 banks on that same day
to determine the lending rate for all banks when they originate new floating rate loans.
This process will then be repeated on the 20th of each month.
Moody's Investors Service said this reform will narrow Chinese banks' lending margins, a
credit negative. The narrower margins on loans will also encourage banks to increase their
risk appetite and, as a result, weaken asset quality.
According to the PBOC, the National Interbank Funding Center will announce the new LPR
at 9.30am on the 20th of every month. A five-year tenor will be added to the existing one
year LPR to serve as a reference rate for banks pricing long-term loans such as mortgages.
To expand the representativeness of the LPR, the PBOC also included eight small banks -
including two city commercial banks, two rural commercial banks, two foreign banks, and
two private-invested banks - to the existing 10, including state-owned and joint-stock
commercial banks, participating in LPR quotations. Banks' use of LPR as a pricing
reference will be included into and evaluated by China's Macro Prudential Assessment
(MPA).
The new mechanism liberalizes interest rates because it will explicitly replace the
current loan pricing based on benchmark rates, which are not sensitive to changes in
market rates.
Under the current practice, introduced in October 2013, 10 banks decide the LPR on a
daily basis. This gives them little incentive to price their LPR differently than the
PBOC's benchmark lending rate, which has not changed since October 2015. Although this
mechanism was designed to approximate market-oriented interest rates, the actual rate has
closely matched the government's benchmark lending rate. In recent months money market
rates and bond yields have declined substantially but actual bank loan rates have remained
high, resulting in a wider gap above-market interest rates, protecting Chinese banks'
lending margins. (KL)

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