Friday, December 24, 2004

I recently had a discussion with a friend about the October interest rate liberalization. In October, the PBOC announced that it would in principle liberalize lending interest rates for major financial institutions. According to a report by an investment bank, banks are nonetheless still charging the official PBOC lending interest rates. The question is why.

Why not take a chance with higher risk loans and charge higher interest. After all, this is what the underground banks have been doing for years. As US lenders have known for years, the "sub-prime" market can be very lucrative. Nonetheless, banks are still reluctant to do so. One reason is that the CBRC still watches NPL ratio very, very closely. This means that banks still would rather lend to safe firms at lower rates than to more risky firms at a higher rate. Bankers are also afraid that too much lending to risky private firms will bring charges of corruption. I just wonder if there is an unofficial policy besides the official one about lending interest rate.

The real test will come if inflation goes up. If that happens, will the PBOC "stand idly by" as lending interest rates climb above the 10% level? Of course, this round of liberalization might suggest that the PBOC is now so confident of its monetary instruments that they don't forsee any inflation problems in the future.

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