China rate cut a gamble that banks will boost economy

Fri Jul 6, 2012 6:57am EDT
 
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By Kevin Yao

BEIJING (Reuters) - China's second surprise rate cut and lending reform in the space of a month shows that Beijing wants borrowing to play a greater role in reviving an economy struggling with its weakest pace of growth since the global financial crisis.

But the approach that policymakers have adopted also highlights the constraints they face in trying to steer credit to the parts of the economy that need it.

The easiest way to create credit is simply to free the country's four biggest banks to lend up to the 75 percent loan-to-deposit ratio (LDR) regulatory ceiling. They all have lower ratios.

Since the top four hold more than half of total deposits, a small adjustment could potentially have a big impact. The risk though is that easing the LDR might simply fuel overcapacity in inefficient industries without improving growth prospects.

"Bringing up the loan-to-deposit ratio is probably a better move to spur lending, but it's a long-term systemic risk," said Sheng Nan, an analyst at CCB International, the HK investment banking arm of China Construction Bank.

"They ultimately want banks to be domestic deposit funded, and an easing of LDR may shift funding towards wholesale lending."

Therefore, policymakers have adopted a more complex path of bringing down borrowing costs while trying to persuade banks to more actively manage their loan books.

They are trying to overcome the tendency of state-backed banks to extend extra credit to big, cash-hoarding state-owned enterprises and over-extended property developers.   Continued...

 
Vendors nap on chairs amongst boxes of fruits at a wholesale fruit and vegetable market in Wuhan, Hubei province July 6, 2012. REUTERS/Stringer