Q: Please provide more details onthe People's Bank of China's recent decision to widen the floating band oflending rate of the financial institutions and lower the interest rate on theirexcessive reserves? When will relevant changes take place?
A: Approved by the State Council, the PBC decided towiden the floating band of lending rate of the financial institutions effectiveJanuary 1,2004. For the commercial banks and urban credit cooperatives, theupper limit of their lending rate will be raised to 170 percent of thebenchmark lending rate set by the PBC. For the rural credit cooperatives, theceiling will be raised to 200 percent of the PBC's benchmark rate. The lowerlimit of the lending rate of all financial institutions will remain at 90percent of the PBC's benchmark rate. Take the one-year term loan for example,its current benchmark rate is 5.31 percent. After the floating band of lendingrate is widened, the commercial banks will be able to set their own lendingrate within the range of 4.78-9.03 percent on commercial basis, no longercontinuing the practice of charging different rate to enterprises of differentownership and size. Interest rate on loans provided by the policy banks andthose specified by the State Council will remain unchanged.
The PBC willalso lower the interest rate it offers to the financial institutions on theirexcess reserves from 1.89 percent to 1.62 percent effective December 21, 2003.The interest rate on the required reserves will remain at 1.89 percent.
Q: How does the PBC currentlyregulate the lending rate of the financial institutions?
A: The PBC sets a benchmark lending rate and a rangearound this rate. The financial institutions set their own lending rates withinthis range based on the credit risk and financial performance of the borrower.Different ceilings apply to loans provided to enterprises of differentownership and size and extended by different types of financial institutions.For the commercial banks and urban credit cooperatives, the interest rate theycharge on loans to the key state-owned enterprises may not exceed the PBC'sbenchmark lending rate; that to the large enterprises may not exceed 110percent of the benchmark rate; that to the small and medium-sized enterprisesmay not exceed 130 percent of the benchmark rate. The rural credit cooperativesmay charge lending rate no higher than 150 percent of the benchmark rate. Thelower limit of the lending rate of all financial institutions will remain 90percent of the PBC's benchmark rate. Interest rate on loans provided by thepolicy banks and those specified by the State Council may not be higher thanthe benchmark rate.
Q: Why has thePBC decided to widen the floating band of lending rate of the financialinstitutions?
A: Since 1998, the PBC has taken gradual steps towiden the floating band on lending rate of the financial institutions. Withwidened lending rate band, the financial institutions has been more willing toprovide loans to small and medium-sized enterprises (SMEs). These enterpriseshave gained easier access to bank credit, and employment and reemployment hasimproved. However, as economic situation changes, the existing policy onlending rate has faced several problems. First, further development of SMEs isrestrained. The ceiling of the lending rate band is relatively low. Theinterest income received by the financial institutions is not sufficient tocover the cost and risk, making them less willing to extend loans to SMEs.Second, with the ceiling on lending rate relatively low, some loan officers maytend to abuse their power and seek personal gains, undermining the creditmanagement system of the financial institutions. Third, the practice ofcharging interest rate based on the ownership and size of the borrowingenterprises is in contradiction with the principle of fair and equitabletreatment in a market economy. Moreover, as the market economy furtherdevelops, it will become more and more difficult to strictly define the sizeand ownership of the enterprises. Wider floating band of lending rate will helpcreate a fair market environment, support the development of the SMEs andcreate more jobs, promote the reforms of the financial institutions, reduceprivate lending with unduly high interest rate, and maintain a healthyfinancial market order.
Q: Will the financing cost of thekey state-owned enterprises become higher as a result of wider floating band oflending rate?
A: No. Many of the key state-owned enterprises arelarge enterprise groups with considerable market share, sound performance andhigh credibility. Based on their loan-granting principles, the financialinstitutions regard these enterprises as prime customers and chargebelow-benchmark interest rate on the loans extended to them. In addition,according to international practices, borrowing rate is an important indicatorof the economic strength of an enterprise. A financial institution determinesthe interest rate it charges on a loan based on the performance, creditstanding and risks of the borrowing enterprises. The low rate charged to thekey state-owned enterprises with good performance is the result of competitionin the credit market and a manifestation of their own strength. Wider floatingband of lending rate and equal treatment of enterprises with differentownership and size will help create a more favorable environment for the keystate-owned enterprises to demonstrate their true economic strength and seekfurther development.
Q: Will widerfloating band of lending rate result in general increase in the interest rateon loans?
A: No. First, at present, there are sufficient fundsavailable to meet the need of economic development. This is the main factorthat determines the basic stability of lending rate. Second, as the financialinstitutions transform their operating mechanism and strengthen their riskmanagement, they no longer regard the expansion of credit as their majorobjective. At present, they have basically established credit management systemwith separated functions of loan approval and loan extension and authorizationmechanism. Management of the lending rate structure has been incorporated intothe overall credit management system. Wider floating band of lending rate willenable the financial institutions to establish a sound loan rate structuretaking into account various factors including the credit risk of the borrower.So there will be no general increase in the lending rate. Third, with increasedcompetition in the credit market, the financial institutions will refrain fromany rush decision to raise the interest rate on loans to their prime customers.As of the end of September 2002, of the total outstanding loans of thecommercial banks, those with interest rate equal to the benchmark rate and 0-10percent, 10-20 percent and 20-30 percent higher above the benchmark rateaccount for 57 percent, 20.7percent, 9.9percent and 12.5percent respectively.This shows that, with the gradual widening of floating band of lending rate,the financial institutions have not raised the interest rate on all loans tothe upper limit. Instead, by differentiating between borrowers, they have setup a sound interest rate structure.
To ensure the smooth implementation of these measuresof interest rate reform, the PBC require that the financial institutionsstrengthen their risk management system and improve their loan pricing mechanisms.They are required to set the lending rate in a fair, equitable and open mannerbased on factors such as the financing cost and the risk and performance of theborrowing enterprises. The PBC will enhance its monitoring, analysis andmanagement of the lending rate of the financial institutions. It will seek tomaintain a healthy order of the financial market by strengthening its roles ofguidance and coordination.
Q: With greater flexibility insetting the lending rate, will the financial institutions have adequatecapability to manage their loans?
A: The financial institutions currently have adequatecapability to manage their loans under a wider floating band of lending rate.
The PBC widened the floating band of lending rate ofthe financial institutions for three times in 1998 and 1999. Accompanying thesemeasures, the PBC also required the financial institutions to set up theirinternal loan pricing and authorization mechanisms. At present, the financialinstitutions have basically established effective interest rate risk managementsystem with relevant rules on loan pricing, risk management and authorizationprocedures. In addition, with basic information system for loan pricinginitially set up, the financial institutions have been able to flexibly set thelending rate based on factors including the financing cost and the risk andperformance of the borrowing enterprises. With the introduction of furtherwidened floating band of lending rate, the PBC has required that all financialinstitutions further enhance their credit risk management system bystrengthening the information system for loan pricing and the internalmanagement system. These efforts will enable them to set the lending rate andmanage interest rate risk more effectively.
Q: What is the interest rate onexcess reserves? Why has the PBC decided to lower the interest rate on excessreserves?
A: The financial institutions hold a certain amountof deposit with the central bank for the purpose of meeting the needs of cashwithdrawal of their depositors and inter-bank settlement. These are therequired reserves of the financial institutions. Excess reserves are thosereserves that exceed the amount required by the central bank. The PBC has beenpaying same interest rate on reserve requirement and excess reserves.
Widening the floating band of lending rate andlowering the interest rate on excess reserves are two related measures. Lowerinterest rate on excess reserves will encourage the financial institutions toutilize their financial resources more efficiently. This will contribute to thesmooth operation of the money market and capital market, and enhance theeffectiveness of coordination between macroeconomic policies. Widened floatingband of lending rate will also help reduce the imbalance between direct andindirect financing, and promote the further development of the capital market.
Q: Pleasebriefly describe the monetary policy stance the PBC is going to adopt in thenear future.
A: In line with the general principle of maintainingthe consistency and stability of macroeconomic policies set by the CentralParty's Economic Conference, the PBC will continue to pursue sound monetarypolicy. It will employ various monetary policy instruments in a flexible way toensure the steady growth of money and credit. At the same time, it will closelymonitor macroeconomic development and take adjustment measures as appropriate.It will strengthen the forward-looking and scientific approach to monetarypolicy formulation and financial management. It will also strengthen thecoordination between monetary policy and other macroeconomic policies tosupport the sustained, rapid, harmonized and healthy development of thenational economy.
