At the start of 2020, China will no longer be using the traditional benchmark lending rate for new loans. The transition is a significant milestone for the country as it represents a big step forward in its market-oriented interest rate liberalization reform.
Analysts have stated that the transition should result in a much more flexible mechanism that will benefit both individuals and companies as they enjoy reduced financing costs. Starting on January 1, banks will be required to use the loan prime rate as their benchmark rate. The loan prime rate was originally introduced by the People's Bank of China (PBOC), the country's central bank, back in August.
Banks and other financial institutions will still be able to negotiate for a higher or lower floating rate based on the loan prime rate. The PBOC clarified over the weekend that loans that have already been issued but not yet due will need their contracts to be renewed with their respective issuing banks before the end of August this year before the interests can be changed into the new loan prime rate.
Starting in January, the loan prime rate will be used to anchor all new home mortgages. However, mortgages already contracted to start in 2020 will remain unchanged. Other mortgages starting in 2021 may be offered with a fixed rate or a floating rate based on the loan prime rate.
The rollout of the new loan prime rate is a result of years of work for the PBOC, which has been advocating for a price-based framework that will feature a market-oriented interest rate for loans and mortgages. The PBOC has pushed for this type of framework as it apparently improves efficiency and provides more flexibility for the country's macroeconomic management.
Since 1996, the PBOC has slowly been rolling out measures as part of its interest rate liberalization reform efforts. The initial measures were mainly aimed at reducing the risk associated with excessive price competition between financial institutions.
Economists have pointed out that the PBOC's rollout of the new loan prime rate is one quarter earlier than expected. The accelerated rollout has been seen as a clear sign of the PBOC's determination to push forward with its lending rate linearization reform.
The loan prime rate, which will be refreshed every 20th day of each month, is expected to significantly reduce financing costs for borrowers. As banks transition to the new prime rate, companies and individuals should be able to avail of cheaper loans with less financing costs. This is expected to offset the current economic downside pressure, which should hopefully bolster economic growth.
