Borrowing costs increase amid tighter liquidity and an overheating economy Mainland banks have stopped extending discounted lending rates to their best customers amid tighter money-market liquidity and expectations of a rise in interest rates, effectively raising capital costs for many Chinese companies. Since January, banks have been allowed to set interest rates within a fixed band near the 5.31 per cent base rate set by the People's Bank of China (PBOC). The band ranges from 4.78 per cent at the low end to a ceiling of 9.03 per cent. In an increasingly competitive lending market, most banks had been willing to offer the minimum rate to their best customers to finance projects and developments. Local governments also lean on branches to lend at the lowest possible rate to favoured companies and infrastructure projects. However, sources at China Minsheng Banking Corp and China Merchants Bank said yesterday that very few borrowers could now qualify for cheaper lending rates. 'We used to give our best customers borrowing more than 100 million yuan the preferential rate, but not now,' one banker said. 'Other banks have also stopped giving their best customers the best lending rate.' The sources added that banks frequently charged 20 per cent to 30 per cent above the base rate in sectors where overheating was most pronounced, such as property development. The PBOC has recently moved to curb lending by twice raising the amount of reserves banks must deposit with it, effectively reducing their usable funds. In particular, it wants to curtail banks' exposure to the aluminium, vehicle, cement, property and steel sectors. The central government is worried about the inflationary consequences of a 43 per cent rise in fixed asset investment over the first quarter of this year - the highest such rate in a decade. The limited freedom mainland banks have to set borrowing costs near the PBOC's base rate is intended to allow them to price loans more effectively and in accordance with borrowers' credit risks. In particular, the reform has given banks an incentive to lend at higher rates to small, medium-sized and private firms that previously could not qualify for loans at the lower rate. 'Banks are apparently trying to maximise their profits,' said Arthur Lau, a credit research analyst at Barclays Capital Asia Pacific. 'They have the flexibility to price their assets to better reflect the risks involved. This is a step towards full liberalisation of the interest-rate regime.' Despite an interest spread of more than three percentage points between lending and deposit rates on the mainland, Mr Lau said heavy non-performing loan burdens meant Chinese banks' net interest margins were only about 1 per cent.