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     BEIJING(MNI) - A drive by Chinese regulators for big banks to lend to the
private sector at a fraction of market rates risks pushing up non-performing
loans and even encouraging dangerous arbitrage if some borrowers use the cash to
invest in high-yielding funds, a government advisor and bank sources told MNI.
     "Small businesses play an important role for employment and economic
growth, but there is a contradiction between their naturally high credit risk
and the low lending rates they are currently enjoying," said Xu Hongcai, deputy
director of the Economic Policy Commission of the China Association of Policy
Science, a state think tank.
     "The repressed lending rate could push up the NPL ratio and hurt lenders'
profits," Xu said, stressing that the credit campaign was unsustainable and
should not be conducted on a large scale.
     A loan manager at a big commercial bank told MNI its average rate for small
businesses was just slightly higher than the benchmark, and much lower than in
the same period of last year. The PBOC benchmark one-year lending rate is 4.35%.
In comparison, non-bank institutions lend to small businesses at around 18%, Li
Junfeng, head of the financial inclusion department of the China Banking and
Insurance Regulatory Commission, said in response to a question from MNI at a
briefing last Friday.
     "The lending rate is at around 5% in most cases at present, but it can be
lower for qualified companies," the loan manager said, asking not to be named.
"We can barely cover our costs and this is squeezing profits, as we obey the
call to surrender a portion of our earnings to small businesses."
     --LENDING DRIVE
     Large state-owned lenders have been asked to increase lending to small
businesses by more than 30% and to cut interest rates on these loans by another
1 percentage point from last year, according to the latest executive meeting of
the State Council chaired by Primer Li Keqiang.
     In March, the China Banking and Insurance Regulatory Commission said growth
in banks' loans to small firms should keep pace with total loans and that
interest rates should be strictly controlled.
     Central government and regulators have been pushing banks to channel more
funding to the private sector since the second half of 2018, as a way of
countering economic headwinds.
     The top five state-owned banks' average lending rate was 4.76% in the first
quarter, down 0.13 percentage point from the fourth quarter last year, the
CBIRC's Li said.
     "If banks can control risks, keeping their bad loan ratio below 3%, their
interest rate should be set between 5-5.7% just for them to stay profitable and
commercially sustainable," Li said.
     --ARBITRAGE RISK
     Very low lending rates could prompt arbitrage, Li said, noting that the
regulator had taken note of the matter. Market sources told MNI that cash from
cheap loans could be directed to high-yielding financial offerings like trust
products. These had an average yield of 8.28% in March, compared with 7.63% in
the same period last year, according to PYSTANDARD, a financial data provider.
     "Banks usually strictly monitor the uses loans are put to, and particularly
loans to small businesses," the bank loan manager said, although he admitted
that arbitrage could occur.
     A manager at a city commercial bank told MNI the People's Bank of China had
cut the reserve requirement ratio of some small- and medium-sized banks which
had passed the quarterly macro prudential assessment in Q1, unlocking capital
for loans to small businesses. But small banks cannot afford to lower their
rates to the same extent as bigger institutions, he said.
     "When the lending rate is lower or slightly higher than the benchmark rate,
small banks are hardly able to make profits and have to shoulder big risks," he
said.
     The manager said he was more concerned about the drain on capital than a
possible rise in bad loans from the lending to small firms.
     "Big banks have many ways to recapitalise, including issuance of perpetual
bonds, but small banks would provide a challenge for the regulators," he said.
--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com
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