Facing Growth Slowdown, China Wants To Allow Banks To Lend As Much As They Desire To Help Spur Economy

As growth in China slows, the nation is looking to crank up its credit machine and allow its banks to lend as much as they desire in a move to help boost economic growth.

In one of its boldest and riskiest steps in banking reform, China is moving to end a two-decade-old banking rule that has capped lending relative to deposits.

Late on Wednesday, China’s cabinet, the State Council, published its decision as part of a draft amendment to the nation’s 20-year-old commercial banking law.

The new measure by China will help boost credit expansion as the nation looks to revive economic growth as Premier Li Keqiang seeks to usher in market-based economics.

The draft amendment to the banking law in China proposes the removal of the lending cap that has long barred banks from lending more than 75% of their deposits. 

In a nutshell, the move would scrap the loan to deposit ratio (LDR), which is a way of regulating bank liquidity, from a legal limit to a mere guideline for commercial banks.

The draft amendment will be submitted to the Standing Committee of the National People’s Congress, China’s parliament, for the final approval, the cabinet said. However, it didn’t provide a timetable.

Here’s more from Reuters:

Removal of the debt-to-loan ratios (LDRs) would potentially allow 16 listed banks to release up to 6.6 trillion yuan ($1.1 trillion) in extra lending, some analysts estimate. That should in theory give an extra fillip to the slowing economy, though banking sources have told Reuters that loan demand is weak as companies struggle with sluggish sales and are in no mood to make fresh investments.

Here’s more from Bloomberg:

While the change has the potential to boost credit growth, a bigger constraint may be limited demand for funds in a faltering economy. Looming now is what the central bank has called one of the “riskiest” parts of financial reform: ditching a ceiling on the interest rates that lenders pay on deposits, a move that may come in the second half of this year.

Here’s more from Quartz:

The proposal—which will, in theory, free up enough credit for small, private-sector businesses—is a sign that monetary policy has so far failed to get capital to the most vibrant part of China’s economy, says Andrew Polk, economist at the Conference Board.

“The mechanisms for banks to get credit to parts of the economy that really need credit right now—especially SMEs [small- and medium-sized enterprises]—aren’t working,” says Polk. “They’re doing anything they can to make that transmission flow better—to un-gum the lending process.”

. . .

Tellingly, Chinese authorities’ moves may actually reveal a more serious problem in the country’s banking system right now. Today’s announcement comes mere days after the PBoC reported the lowest loan demand (pdf) it had ever seen. This is odd given the PBoC’s profuse loosening of late, says Christopher Balding, associate professor at Peking University HSBC Business School, Shenzhen—and could imply a much higher level of bad loans than official data suggest.

 “[E]ven though they keep releasing all this additional capital, it appears to not be enough and new loan growth isn’t showing a bump,” says Balding. “If people are paying their loans and new capital is being released we should see a bump in lending.”

China’s Central Bank, the People’s Bank of China (PBOC), has cut interest rates three times in the past seven months in an effort to lower borrowing costs and give banks more flexibility on how much they pay depositors.

Chinese Premier Li Keqiang is aiming to overhaul its state-run banking industry that has around $29 trillion of assets, nearly twice the amount of that in the U.S.. Deregulating the nation’s interest rates and easing regulatory controls are part of Li’s efforts in order to support long-term growth by thus giving markets a larger role in the economy.

China’s economic growth in the first quarter (Q1) of 2015 reached the slowest quarterly pace in six years at 7 percent from a year earlier, as it was dragged down by a combination of an industrial slowdown and a weak housing market.

Earlier in March, China lowered its economic growth forecast to “about 7 percent” in 2015 as the nation adjusts to a “new normal” of slower but more sustainable growth.

A full-year growth rate of 7 percent would be its slowest annual rate of expansion in 25 years.