Chinese Court Lowers Interest Rates Allowed on Private Loans

Chinese Court Lowers Interest Rates Allowed on Private Loans

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(Bloomberg) — China’s Supreme Court ordered interest rates on private loan agreements between individuals and small businesses to be lowered by as much as 10 percentage points, a ruling it said will foster economic growth and stabilize the sector.

Under a revised ruling passed this week, rates exceeding four times the benchmark Loan Prime Rate will be treated as usury and invalid, the Supreme People’s Court said Thursday. Based on the latest LPR, the ceiling would be lowered to 15.4% from a range of 24% to 36% under a previous judicial interpretation in 2015.

The move is aimed at promoting economic growth and ensuring healthy and stable development of the private lending sector, according to the court. He Xiaorong, an official with the Supreme Court, said at a briefing that there were more than 2 million private lending disputes filed a year in recent years.

The court also acknowledged that it “isn’t necessarily the lower the better,” said He. Low rates could lead to a shortage of credit and push private lending underground, the official said.

China is stepping up efforts to revive the world’s second-largest economy and backstop millions of small businesses struggling to stay afloat after the outbreak of the pandemic and a trade dispute with the U.S. Banks have also been ordered to lower rates, forgoing more than $200 billion in profits to support the recovery.

Private lending is part of China’s nebulous world of shadow banking, which rebounded in the first quarter to 59.1 trillion yuan ($8.5 trillion), according to Moody’s Investors Service. The up-tick highlights challenges faced by policy makers who are struggling to keep liquidity ample without fueling a debt bubble.

Informal lending, which includes financing leasing, micro-credit, pawnshop loans, online peer-to-peer lending, was estimated at 3.4 trillion yuan as of March 31, according to Moody’s.

Before a let-up due to the pandemic, the nation had been in a multi-year campaign to crack down on financial risks and contain shadow banking. During the boom years, the market was a lifeline for many small enterprises unable to get loans from regular banks. About two-thirds of the country’s 80 million small businesses lacked access to loans as of 2018, according to China’s National Institution for Finance & Development.

Analyst were skeptical, arguing the ruling could raise risks in the system.

“The new cap breaks the market norm of risk pricing,” said Dong Ximiao, a researcher at Zhongguancun Internet Finance Institute. “Some private funding may be withdrawn from the market due to rising legal risks. Some bad-faith borrowers could renege on their loans agreements and that’s additional risks to lenders.”

China revamped its system of interest rates last year with the aim of making them more market-oriented. The new market benchmark LPR is determined by submissions from a panel of 18 lenders rather than set by the central bank.

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