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China lending tweak shifts emphasis to quality from quantity

[SHANGHAI] China's decision to scrap limits on how much of their deposits banks can lend won't immediately revive its slowing economy, but it is likely to be celebrated in the boardrooms of smaller banks and ultimately by the private business community.

The Chinese economy, growing at its slowest pace in decades, has proven unresponsive to repeated cuts to guidance interest rates and banks' reserve requirements, so Chinese policymakers appear to be turning to reform to help restart investment, removing administrative shackles that hold back lending to productive companies.

China's cabinet on Wednesday proposed scrapping a cap that currently limits banks' lending at 75 per cent of deposits, and bankers said the change will both reduce their funding costs and free them from the need to scramble to acquire deposits before they can issue loans.

Some believe the loan-to-deposit ratio (LDR) cap implicitly favours China's "big five" state-owned banks, which typically hog the lion's share of deposits but tend to prefer lending to often inefficient state-owned industrial giants.

Many economists say that has inadvertently contributed to overcapacity in some of China's least competitive firms and to asset bubbles, as many state companies, facing dubious prospects in their core businesses, have taken out cheap loans to speculate in real estate or stocks. "While scrapping the LDR is unlikely to have much impact on overall lending growth, it will impact the distribution of lending between banks," wrote Julian Evans-Pritchard of Capital Economics in a research note, adding that smaller banks'enthusiasm for shadow banking suggests they are more eager to lend.

That in turn would encourage banks to support innovation and new start-ups, said Wen Bin, analyst at Minsheng Bank. "The government is encouraging mass innovations which are related to small businesses that could help boost demand for loans and financial services," he said.

The step follows other tweaks to money management tactics that are seen as rebalancing funding costs to encourage more long-term borrowing and less short-term speculation, as previous easing moves have done little to spur fresh investment. "Without reforms, policy tools cannot be very effective. We need to open up the financial industry," said a senior economist at a think-tank connected to the government. "We should have a market-based financial system which will help improve monetary policy transmission."

Chinese state-owned banks have remained reluctant to lend to riskier private firms, and Chinese executives have been unwilling to borrow at high rates for low returns, preferring to pay down debt and wait for a turnaround.

Though some recent surveys have shown signs of tentative recovery in real estate and inflation, a lack of investment has continued to hamper China's recovery.

Bankers and loan officers who spoke to Reuters welcomed the reform and agreed it would benefit smaller lenders, but did not expect a rapid resurgence in lending. The amendment still needs approval by the Standing Committee of the National People's Congress, China's parliament.

While in theory economists estimate the change could free up between 1.1 trillion and 3.5 trillion yuan in lendable capital, it is unlikely to do so in practice.

Official data from the banking regulator shows the average loan-to-deposit ratio was only 66 per cent at the end of the first quarter, far below the regulatory limit, calling into question assertions that the LDR has been a major barrier to lending. "There will be some impact, but it won't be big," said an executive at a mid-sized bank who declined to be named, though he did note this would ease pressure on banks to load up on deposits before they can lend more.