MNI PBOC WATCH: Bank Margin Squeeze Weighs On 5-Yr LPR Outlook

Banks may be reluctant to offer lower quotes on the five-year Loan Prime Rate (LPR) due to a rise in wholesale funding costs, despite concerted efforts by China’s government to stabilise the troubled property sector, advisers and analysts said.

The People’s Bank of China will update the LPR on Tuesday based on the rate on the PBOC’s Medium-term Lending Facility (MLF) and quotes submitted by 18 banks. The LPR was left unchanged for the one-year maturity at 3.65% and the over-five-year maturity at 4.3% in November.

A LPR cut may be less likely following the PBOC’s lowering of the reserve requirement ratio (RRR) on December 5, which freed up capital and lowered financing costs for lenders, and after the central bank kept the MLF rate steady last week, Dong Ximiao, chief researcher at Merchants Union Consumer Finance, told MNI. However, he said the central bank should guide the over-five-year LPR down to boost long-term credit demand among households and companies.

The closely watched Central Economic Work Conference concluded last Friday, telegraphing that monetary policy next year would be “precise and forceful” and that liquidity would be kept “reasonably ample”.

Dong interpreted those signals to mean the RRR and the over-five-year LPR, which is used to price mortgages and long-term bank loans, are likely to be lowered to expand domestic demand, while structural facilities would continue to be deployed and target key sectors.

The central bank has increased its liquidity injections to meet rising year-end cash demand as lenders buttress their balance sheets ahead of quarter-end macro-prudential assessments. In addition to the CNY500 billion of liquidity unlocked via the 25bps RRR cut, the PBOC provided a net CNY150 billion MLF last week, the first net injection of MLF in 9 months. According to the PBOC, M2 jumped by 12.4% year-on-year in November, the fastest monthly expansion since April 2016.

MARGIN SQUEEZE

The LPR was unlikely to be lowered in the absence of a cut in the MLF rate as banks’ interest margins are being squeezed, said Zhang Yu, chief analyst at Huachuang Securities.

She estimated commercial banks would lose as much as CNY100 billion in interest revenue in 2023 as mortgage rates will be lower from early next year following the lowering of the LPR in 2022.

While the PBOC has calculated the latest RRR cut would save lenders CNY5.6 billion a year, it isn’t enough of an incentive to lower their LPR quotes, she said. She noted the PBOC was likely to cut the MLF rate once the U.S. Federal Reserve pauses it rate hiking campaign.

Banks are confronting rising funding costs as bond pricing reflects concerns about the prospect of tighter policy once the economy rebounds. Additionally, wealth managers continue to redeem products, which has rattled bond market confidence. This has steered the rate on Negotiable Certificates of Deposit, a major tool for banks to raise funds in the interbank market, to 2.72% on one-year products rated AAA last week, the highest level this year.

A lower LPR could help send an easing signal, lower lenders’ funding costs and boost market sentiment, analysts suggested.

The five-year LPR could be lowered this month or in January as deposit rates have decreased since September, which has lowered lenders’ funding costs, said Wang Qing, chief macroeconomic researcher at Golden Credit Rating. Wang thinks the recent RRR cut could push banks to lower their LPR quotes.