STATE OF PLAY: China LPR Seen Steady, Before Cuts Later In '22

China’s Loan Prime Rate is expected to be cut over coming months after banks moved to protect net interest margins by lowering deposit rates, but analysts said the LPR should be kept steady on Tuesday in line with the People's Bank of China’s decision to leave its medium-term lending facility rate unchanged on Sept 15.

While the 18 lenders surveyed for the LPR may keep quotations unchanged this month, there will be room for future reductions after big state-owned banks and most medium-sized commercial lenders cut deposit rates from Sept 15, said China Minsheng Banking Corp chief economist Wen Bin.

He predicted the five-year LPR could be lowered in November or December to boost mortgage loans and support the economy, though the one-year LPR is likely to be kept steady to avoid fuelling carry trades. In August, the PBOC cut its 5-year LPR rate by 15 basis points to 4.30%, and lowered its one-year rate by 5 basis points to 3.65%, in a surprise move seen as aimed at bolstering an economy suffering from Covid lockdowns and a weak property sector.

The PBOC’s recent moves indicate it is seeking to lower borrowing costs and increase loan issuance, but also to tighten liquidity and force money market rates up towards policy rates, noted CITIC securities chief economist Ming Ming, noting how the partial rollover this month of maturing MLF drained excessive interbank liquidity. MLF injections may continue to be reduced over the next few months, though this will depend on credit expansion and the pace of economic recovery, Ming said.

INTEREST MARGINS

According to big banks’ websites, demand deposit rates were cut by 5bps, three-year rates by 15bps and other maturities by 10bps last week.

The cuts should expand credit, channelling capital into the real economy, and boost consumption, Wen said. Three-year deposit rates comprise a particularly large portion of banks’ funding costs, he noted.

Net interest margins for commercial banks dropped to 1.94% in Q2, 12 bps lower than the same period last year and 3bp lower than Q1, according to the China Banking and Insurance Regulatory Commission. Topsperity Securities calculated banks’ net profits may fall about CNY77.7 billion to CNY145.3 billion in 2022 as authorities require lenders to “surrender some profits to the real economy” by reducing the cost of loans.

Wen said banks have benefited from lower money market rates since April, and otherwise net interest margins could further narrow given an increase in deposits and a drop in real loan rates since Q2.

RATE REFORM

Economists believe the deposit rate cuts, the first across-the-board reduction since 2015, will push China’s interest rate pricing reform forward.

It was the first time China’s banks broadly adjusted deposit rates while the benchmark deposit rate remained unchanged, said Cai Hao, a researcher at the National Institution for Finance and Development. He said the partial “decoupling” between benchmark and real deposit rates represented another step towards a market-oriented interest rate pricing system.

Since April, the PBOC has required some banks to price deposits by referencing the 10-year government bond yield and the LPR rate, a move aimed at tightening the link between loans and deposits, as well as at liberalising deposit rates.

Cai said deposit rate cuts of 5-15bps were in line with the fall in 10-year bond yields by 15-20bps and with 15bps of LPR cuts so far this year.

Wen noted a growing connection between the MLF rate, LPR pricing, 10-year bond yields and deposit rates, in line with the market-oriented reform of deposit rate pricing.