China will remove the ceiling on interbank rates from Saturday, taking another small step towards freeing its state-controlled interest rates.
The People's Bank of China (PBOC) said the lending rates for contracts of seven, 20, 30, 60, 90 and 120 days would be left entirely to borrowers and lenders, based on demand and supply of funds.
When the interbank market was implemented in January, the central bank had placed a cap on the rates to prevent sharp upswings. But the rate for the contracts - China interbank offered rates (Chibor) - generally had been stable and within the upper limits. 'As this is the year of interest rate reforms, the PBOC has to take incremental steps to move in that direction,' a Bank of China economist said.
The central bank wanted to develop Chibor as a benchmark for other short-term interest rates, but the economist said it would be at least three years before this could happen.
Analysts said although the cap would be phased out, the interbank borrowers and lenders were still not entirely free to decide Chibor because the savings and deposits rates were decided by the State Council.
An analyst said: 'What this means is that there is still a strong element of guidance at the retail level, which does affect the other interest rates.' He said because lending by the state banks was controlled through a national credit plan, interest rates were not market-driven.
'You have to abandon the credit plan to remove the controls on lending if you want to establish true market-driven rates,' he said. In the black market, lending rates were reportedly exceeding 20 per cent at the retail level, way above the official rates.
Analysts said the demand for funds remained extremely tight, but that was not reflected in the official cost of borrowing because of credit and interest rate controls.
Traders said although the interbank market was designed to facilitate efficient borrowing and lending on a national level, banks in the interior cities often had difficulty borrowing.
Interbank Lending Market
A trader said: 'These banks usually have to pay a premium to borrow in the market, which defeats one of the aims of the interbank market.'