China unlikely to liberalize lending rates in 2009

By Langi Chiang - Analysis

BEIJING (Reuters) - Fears over the impact on bank earnings are likely to delay a long-awaited liberalization of Chinese interest rates, even though it would lower borrowing costs and give a boost to the world's third-largest economy.

Zhou Xiaochuan, governor of the People's Bank of China, said during the recent session of parliament that the central bank would study a plan to let banks charge less for loans; currently, lenders may offer a discount to benchmark rates set by the PBOC of no more than 10 percent, a favor enjoyed mainly by big firms.

But the research could take a year or more.

Analysts say the central bank is unlikely to be in a hurry because banks face a squeeze on their net interest margins and a possible rise in bad loans from the slowing economy.

Lowering the minimum lending rate would further compress interest income, which is the lifeline of every bank in China despite increasing efforts to diversify revenue streams.

"As far as we know, it's impossible to implement under the current circumstances," Yang Qingli, head of research at BOCOM International in Hong Kong, said of Zhou's intention.

China started to liberalize interest rates in 1996 and abolished the ceiling on lending rates in October 2004, encouraging banks to charge more for riskier credits.

But the state still ensures a built-in margin for banks to prevent ruinous competition in a sector only recently nursed back to rude health through a $500 billion multi-year bailout.

In addition to the floor on lending rates, banks may offer depositors no more than benchmark rates set by the PBOC. For the one-year maturity, this is 5.31 percent for loans and 2.25 percent for deposits.

Removing these restrictions is a goal of the ruling Communist Party's five-year plan for the period 2006-2010, but Yang said the central bank might miss the deadline.

BIG IMPACT

Wu Yonggang, a senior financial analyst at Guotai & Junan Securities in Shanghai, said the floor rate was unlikely to be lowered this year.

"The impact on banks would be huge," he said.

Banks are already steeling themselves for margin compression.

Industrial and Commercial Bank of China (1398.HK) (601398.SS), the world's biggest lender by market capitalization, enjoyed an increase in its net interest margin to 2.95 percent in 2008 from 2.8 percent in 2007.