China's policymakers need to activate weak investments to save jobs, but a sharp cut in interest rates could further increase debt and squeeze bank profit margins, thereby exacerbating financial risks.
However, as the economy cooled, analysts said that China launched a landmark reform last week, paving the way for the first time in four years to reduce the target policy interest rate. China is expected to act by mid-September, in line with the expected time for the Federal Reserve to ease its policy.
However, as bankers and regulators gradually adapt to the new and more market-oriented loan pricing system, the initial rate cut is expected to be modest. Analysts said that the People's Bank of China would not initially put too much pressure on banks to cut interest rates.
Lu Zhengwei, chief economist of Societe Generale Bank, said that the first step is to ensure a smooth transition. If the interest rate spreads widen, it would be good, but if the interest rate spreads narrow, it would be troublesome.
In order to reduce the pressure on bankers, the Central Bank of China is expected to cut the medium-term lending facility (MLF) interest rate first to reduce the financing costs of the bankers. This will pave the way for lowering the loan market quotation rate (LPR); the next time to set the LPR is September 20.
MLF is the basis for the formation of new LPR interest rates, but bankers can add premiums to reflect financing costs and credit risks.
"No matter what the final interest rate is, the net interest margin of small and medium-sized bankers will certainly narrow," said the city commercial bank executive, who declined to be named.
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