China: LPR reform to improve policy pass-through – Standard Chartered

Standard Chartered analyst’s note that according to the statement from the People’s Bank of China (PBoC) dated 16 August, the loan prime rate (LPR) will replace the conventional benchmark loan rate (BLR) as the main reference rate for new bank loans, effective immediately.

Key Quotes

“The following major changes have been made as part of the LPR reform:

1.     Publish the new LPR at 09:30 on the 20^th of each month, rather than daily

2.     Expand the number of LPR submission banks to 18 from 10

3.     New LPR to be quoted with reference to the 1-year medium-term lending facility (MLF) plus a spread, no longer linked with the BLR

4.     Introduce a new 5-year LPR for mortgage and long-term loan pricing

5.     Revise macro-prudential assessment (MPA) criteria to ensure new loans are priced on the LPR and banks do not set an implicit floor for the lending rate.”

“LPR reform will have the following major effects on banks and markets, in our view:

1.     Better pass-through of PBoC’s policy rates to banks’ lending rate via the revised LPR and MLF operations, leading to lower financing costs for corporates

2.     Pick-up in banks’ demand for bonds as returns on loans fall;

3.     Likely fall in deposit and wealth management product (WMP) rates over time as banks are under pressure to protect their net interest margins (NIMs)

4.     We expect the PBoC to cut the reserve requirement ratio (RRR) and MLF rate in 2019 to alleviate pressure on banks’ NIMs and return on equity (ROE), and achieve sustainable credit growth

5.     The PBoC will need to conduct MLF operations more frequently and broaden the scope of collateral to improve the influence of MLF on banks’ funding costs

6.     Demand for LPR hedging is expected to pick up strongly

7.     The concept of funds transfer pricing (FTP) will be enhanced.”