Direct Policy Instruments

Bank Lending Rates

The Chinese government adopted a very cautious and gradual

approach towards interest rate liberalization. Liberalization of the
lending rates first started in 1998. The goal was to give commercial
banks more authority in pricing their deposits and loans. The gap
between the interest rate ceiling and floor was gradually widened
over time before being finally removed. Initially, banks could set
lending rates between 90% and 110% of the benchmark rate for
large enterprises, and between 90% and 130% of the benchmark
rate for small- or medium-sized enterprises. Five years later, the
retail lending rate ceiling was removed, but the lending rate floor
was maintained for about eight more years. In 2012, the lending rate
Descriptions (How is policy
floor was further lowered to 70% of the benchmark rate and 1 year
formulated and
later, the lending rate floor was totally removed, suggesting that the
implemented)
PBOC fully liberalized the retail lending rate.

Bank Lending Rate Liberalization

Bank Deposit Rates

Descriptions (How is policy
formulated and Liberalization of the deposit rates took even longer. The government
implemented) was more cautious on deposit rate deregulation in order to suppress
irrational competition among banks as China did not have a deposit
insurance scheme until 2015. The PBOC removed the deposit rate
floor in 2004, but banks could not offer higher deposit rates to gain
more market share until 2012. The benchmark rate set by the PBOC
served as the deposit rate ceiling for about 8 years. Since June 2012,
banks could offer deposit rates as high as 110% of the benchmark
rate to their customers. Two years later, the deposit rate ceiling was
raised to 120% of the benchmark rate. In 2015, the PBOC quickened
the pace of deposit rate liberalization. The deposit rate ceiling was
raised to 130% of the benchmark rate in March and further to 150%
in May. On October 23, the PBOC removed the ceiling of the deposit
rate, signifying that China has completed liberalization of both the
retail deposit and lending rates. At the same time, China introduced
a deposit insurance scheme which covers RMB 500,000 for each
 account, thus paving the way for more competition among banks in
China.

The long-run and the short-run pass-through from the policy rates to
retail lending rates became faster and more complete after interest
rate liberalization. China’s financial system reform has successfully
enhanced the competition level of its banking sector. China’s
Implications/Outcomes/Goals
interest rate liberalization does not negatively affect monetary policy
(lending and deposit rates)
transmission. In contrast, it was found that after liberalization the
mark-up is lower, the long-run interest rate pass-through is more
complete and the short-run pass-through is faster and more
complete.

How Much to Lend

Descriptions (How is policy
formulated and Technically there is no legal limit on a company’s local debt with a
implemented) Chinese bank. However, as a practical matter, foreign companies
generally must demonstrate three years of profitable history in
China and have qualified local collateral before they can be
considered for a local China bank loan. Therefore, local debt is not a
viable option for most foreign start-ups in China. Most foreign
companies in China must rely on loans from their foreign parent
company for debt financing to optimize the capital structure of the
China entity.

Once you have modeled your capital requirements (ignoring any

debt component) and added sufficient cash cushion to cover the
inevitable variability of actual cash needs, Total Investment will be
equal to the maximum negative accumulated cash flow in the month
totals, as indicated above. Due to the limits to putting cash into a
China business, it is highly advisable to generate a monthly forecast
of cash requirement for the first three years or until the business
becomes cash flow positive and begins to self-fund capital
requirements.

Once you have determined this maximum negative accumulated

cash flow figure, you have defined the Total Investment metric that
must be included in the business license application process. Plus,
you are now able to determine the maximum legal amount of
foreign debt your China Company may have from any source at any
time, unless you file to change your Total Investment and Registered
Capital.

China investment regulations allow for a higher percentage of debt

for projects with greater Total Investment:

Implications/Outcomes/Goals
To Which Sector/Firm
Descriptions (How is policy
formulated and
implemented)
Before any foreign debt can extended by a foreign parent company
to a Chinese subsidiary or JV, the full amount of the Registered
Capital contribution must be completed. The rationale is that China
wants permanent capital (equity) to be contributed before
temporary capital (debt) is contributed.
Bank lending is the main external source of business funding in
China, accounting for around 59 per cent of total funding. It is
particularly important for private firms because they tend to have
less access to capital markets than SOEs. There are no up-to-date
official data on bank lending to the private sector, but proxies can be
used to make broad-based assessments of the cost and availability
of bank credit. This article takes firm ownership as classified by
WIND Information, where SOEs include only wholly state-funded
firms.
The cost of bank funding is generally thought to be higher for private
than state firms. This appears to be confirmed by implied interest
rates constructed from the financial statements of listed
companies. The rates facing both state and privately listed firms
increased over 2017 and 2018; this is consistent with the tightening
phase of financial conditions for private firms, but also suggests that
access to bank financing had become more expensive for all
borrowers (Graph 1). Implied rates for private firms remain higher
than those for state firms, which is consistent with the commonly
cited view that state firms receive loans on better terms. During
2017–18, tighter regulatory scrutiny left banks less willing, and less
able, to lend to firms with higher credit risk. This widened the spread
between the implied interest rates for listed private and state firms.
In 2019, the implied interest rates for private firms declined slightly
and the spread narrowed, reflecting the phase of easing financial
conditions after a range of policies were put in place to support the

Implications/Outcomes/Goals
private sector.
Proxies for loan growth indicate that it became more difficult for
private firms to obtain bank funding in 2018. MSE data are often
used as a proxy for the private sector, including by the authorities,
since MSEs tend to be privately owned. In 2016, lending to MSEs
accounted for around half of outstanding loans to private firms. A
survey on loan demand published by the People's Bank of China
suggests that MSEs' demand for bank credit actually increased over
this period, implying the fall in lending was primarily driven by
supply factors, consistent with the regulatory tightening. State-
owned banks may face incentives to lend to state firms which could
impede the ability of private firms to access bank funding. Since
2019, loan growth to MSEs has increased, particularly following the
outbreak of COVID-19.
Small and opaque private firms have difficulty obtaining external
financing not only because they represent high risk and high unit
transaction costs, but also because state policy is somewhat biased
against lending to private enterprises. When a public borrower fails
to amortize a loan, the state will almost certainly step in so that the
bank will not have to absorb the entire loss on its own balance sheet
(Lardy 1998).4 But when a private borrower fails, banks appear to
have no recourse but to absorb the loss from their own provisions
and profits. Until the asymmetry in risks associated with different
types of ownership is eliminated, banks feel they must be careful
about lending to private sector firms. Banks therefore need added
incentives to lend to private enterprises. One such incentive could
be the expectation of higher returns, except that most banks in
China are owned by the state and face limited competition, with the
result that the profit incentive is weak.
https://fbr.springeropen.com/articles/10.1186/s11782-019-0056-z#:~:text=The%20Chinese
%20government%20adopted%20a%20very%20cautious%20and%20gradual%20approach,pricing
%20their%20deposits%20and%20loans.

http://www.chinacentric.com/financing-a-china-company.html

https://www.rba.gov.au/publications/bulletin/2020/sep/private-sector-financial-conditions-in-
china.html

https://www.ifc.org/wps/wcm/connect/d644e015-7f4a-418f-aa3a-
a775a7692c7e/china_private_ent_FullReport.pdf?MOD=AJPERES&CVID=j1lpM1b