The People's Bank of China (PBOC) has moved a step closer to letting markets set the price of credit after scrapping a key rule governing bank lending rates.
The decision, which takes effect today, gives banks the freedom to charge rates on loans below the official benchmark lending rate.
This effectively creates a market in which banks can discount lending for lower-risk investments and charge higher rates to projects carrying greater risk.
But analysts said the central bank's grip on lending quotas means capital is still unable to move freely in the economy.
"They've only gone part of the way, but China can't afford to go 'cold turkey' on this," said Paul Markowski, president of New York-based MES Advisers and a long-time adviser to the mainland's monetary authorities.
Giving markets free rein to set the price of bank lending and allocate to only the most promising projects would risk turning off the cash taps to thousands of inefficient state-owned enterprises (SOEs), just as the economy is suffering its slowest patch of growth in a year.
Most bank loans in China come from the "Big Four" state-backed lenders - Bank of China, China Construction Bank, Industrial and Commercial Bank of China and Agricultural Bank of China. They allocate credit mainly to SOEs on a PBOC-enforced quota basis. That has concentrated lending to projects and companies on the basis of connections and influence, rather than on prospects for profit.
This has led to massive overcapacity in some favoured industries and a dependence on yet more lending to sustain diminishing returns on growth.
Premier Li Keqiang has said repeatedly that he wants a more efficient allocation of resources to help drive his stated agenda of economic rebalancing.
Analysts regard letting the markets set interest rates as being essential to that effort.
The central bank last tweaked lending rules a year ago, enabling banks to offer up to 30 per cent off the benchmark rate, which sits at 6 per cent. Analysts regard that move as having been ineffective.
Mark Williams, chief Asia economist at Capital Economics in London, points out that only 11 per cent of loans in the first quarter of this year were priced below the benchmark rate.
Meanwhile, keeping a rule that caps deposit rates - one which many analysts predicted would be scrapped this year - is seen as constraining the banks' ability to truly set the price of money circulating in the economy. Failing to give banks control of deposit rates means they are unlikely to slash lending rates, as that could trigger a squeeze on their own lending margins.
"Liberalising lending rates is a relatively moderate measure compared with liberalising deposit rates," Zhang Zhiwei, chief China economist at Nomura in Hong Kong, wrote in a note to clients. "This is another step in interest rate liberalisation, so we see it as a positive action for the economy."
And while that may be so, it is too early to predict that a flurry of other rate reforms is imminent.
"This move is important because it is part of the whole process of easing the flow of capital," Markowski said. "But this kind of major signal, something of this magnitude, typically only happens once a year.
"They'll want time to let this settle down before taking the next step," he added.