China's central bank rolled out new interest rate reforms on Tuesday, granting banks greater autonomy in setting mortgage rates as part of an effort to implement a more market-oriented lending system.
The relaxation, however, immediately resulted in something that Beijing did not want to see - Shanghai took the opportunity to cut the city's interest rate floor below the minimum rates recommended by the central bank.
Beijing and local governments have pushed out a number of regulations to rein in rapidly rising house prices that have made ownership unaffordable for China's middle class. The central government has made clear that it will not relax restrictions any time soon to boost economic growth, which is slowing amid a trade war with the United States.
Shanghai's move to set the floor mortgage rate at 4.65 per cent, some 20 basis points below the People's Bank of China's (PBOC) recommended floor of 4.85 per cent, has underlined the challenges faced by the Chinese monetary authority in blocking cheap funds flowing into the property sector and inflating housing prices.
It has also stirred debate over whether China can reconcile its conflicting goal of raising interest rates to deter property speculators, while cutting costs for borrowers such as single homeowners, workshops and pig farms.
Ding Shuang, chief China economist at Standard Chartered Bank, said property remained an ideal lending target for banks amid China's economic downturn given its safety and relatively high returns.
"Property prices have not fallen significantly and so the (underlying) asset remains solid as collateral," he said. "Compared to small and medium-sized firms, the bad loan ratio of mortgage loans is far smaller and it is easier (to collect)."
Property is one of the most regulated markets in China and large cities like Beijing and Shanghai have a variety of purchase restrictions. Only local residents and people making social security contributions are eligible to buy a flat, with financial regulators controlling access to financing, including mortgage and property development loans, and bond issuance by developers.
Chinese policymakers are unlikely to loosen controls over the property market for fear of accumulating risk, said Zhang Jun, chief economist of Morgan Stanley Huaxin Securities.
While Beijing is concerned about creating a debt-fuelled property bubble and has vowed to curb speculation, house prices in cities like Shanghai remain high due to limited land supply and strong demand, making mortgage loans safe and sound asset for banks.
Household loans, mainly mortgages, accounted over half of all new loans in August, data from the central bank showed. In the first eight months of this year, mortgage loans extended by Chinese banks hit a record high of 3.65 trillion yuan (US$510 billion).
Real estate remains by far the investment of choice for millions of Chinese, meaning the PBOC is facing an uphill battle to limit cash flowing into the market.
The central bank last month rolled out a new lending system for banks by setting a reference rate for first-time loan applicants that could not fall lower than the loan prime rates (LPR), set at 4.85 per cent, and a floor rate for second homebuyers at LPR plus 60 basis points.
The instruction was largely followed across the country. In the capital Beijing, the mortgage rate for first homebuyers was set at 5.4 per cent on October 8, 55 basis points higher than the benchmark, while second homebuyers were charged at least 5.9 per cent. In Shenzhen, rates were set at 5.15 per cent for first-time buyers, with the floor rate for second homebuyers at 5.45 per cent.
Shanghai set a floor rate of 4.65 per cent because the local government wants to keep the average mortgage rate largely unchanged from the previous level of 4.6 per cent, according to a report by the Shanghai Securities News.
Zhang Dawei, a senior researcher with Centaline Property Agency, said the Chinese government was by and large trying to support first-time homebuyers even though it dislikes speculators.
For most Chinese mortgage loan applicants, the change in the way mortgages are calculated makes little difference.
The adjustment is part of Beijing's effort to adopt a US-style interest rate structure to replace an old government-determined system that is a legacy of China's command economy days.
Under the new system, the central bank will decide the base rates in the money market, and banks will use the money market rate to calculate their prime rates, or the rates they charge their best clients.
The central bank, in turn, will calculate on a monthly basis the LPR rates based on a weighted average of the prim rates from 18 selected banks to serve as benchmarks for the whole domestic banking industry.
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