The People's Bank of China (PBOC) yesterday indicated it may broaden the scope of a proposed cap on borrowing from the mainland's interbank market by foreign banks to include domestic banks as well. The announcement - posted on the PBOC Web site - follows strong protests by foreign banks when they learned last December that they were targets of the controversial borrowing cap. 'That proposal [against foreign banks alone] could have gone against [World Trade Organisation] agreements. So they might now be dealing with accusations of discrimination,' Fitch mainland bank analyst Arthur Lau told the South China Morning Post last night. 'But even if that were the case, foreign banks would still be hardest-hit by the proposal because they rely far more on interbank borrowings to fund their lending operations, than domestic banks,' he said. With their massive branch networks and customer deposits, mainland banks have a ready and cheap source of funding to make their loans. Foreign banks, however, rely on bilateral credit lines with domestic banks, and money raised on the interbank market, for their yuan lending activities. Most foreign banks already exceed the 40 per cent ratio proposed for interbank loans against total liabilities, whereas China's biggest bank, Industrial and Commercial Bank of China, has a ratio of just 7 per cent. In yesterday's announcement, the PBOC invited public consultation to a rule which would restrict borrowing periods for money raised on the interbank market to between four months and three years. But this period could be extended once, it added, for a maximum of half the original term of the contract. It said also that the setting of interest rates would be decided by lenders and borrowers themselves and that fees for securing the loan might also be agreed between the parties. But in a key statement, it added that borrowers could not raise more than 40 per cent of their overall yuan liabilities on the interbank market - a proposal already under consideration for foreign banks - and added that this could be applied to domestic banks as well. It repeated also, the earlier advice to foreign banks, that where interbank borrowings already exceed 40 per cent of total yuan liabilities, steps should be taken to progressively reduce these borrowings over the next four years, in order to comply with the limit by December 31, 2006. The PBOC said the objective of the rule was to strengthen risk-management practices of commercial banks in interbank lending. When first mooted in December last year, foreign banks reacted strongly to the proposal and said it would severely curtail their ability to compete with domestic banks. 'This will reduce foreign banks' capabilities in lending much-needed local currency to foreign investors to support their investment projects in China,' an HSBC official said, adding that the bank had conveyed its concerns to regulators in Beijing. The head of the China division at the Bank of East Asia, Raymond Yu, echoed this concern, saying the plan would 'severely restrict' the ability of foreign banks to raise yuan to lend to their customers. Reacting to the latest twist to the saga yesterday, Mr Lau said that if the PBOC went ahead with the proposal and also applied the controversial cap to domestic banks, the move could have unintended consequences. 'The side effect will be to limit the growth of the interbank market. The size of the market will become a simple calculation based on the total size of all balance sheets of banks in China,' he said. But a positive outcome for prudential matching of assets and liabilities, he added, could be that banks would be obliged to go to capital markets and raise more long-term funding, rather than resort to shorter-term funding on the money market. 'That could mean that their books may be better matched,' Mr Lau said.