Chinese banks test repo-linked corporate loans to make pricing more market-based

Chinese banks are experimenting with a novel approach to pricing corporate loans based on short-term market funding costs. This shift from the traditional loan prime rate to the overnight or seven-day depository-institutions repo rate (DR) aims to make borrowing rates more responsive to monetary conditions. Bank of China has introduced DR-linked corporate loans in multiple provinces, recognizing that DR, derived from actual interbank transactions, better reflects banks' funding costs and liquidity.

Analysts caution that while DR makes loan pricing more sensitive to short-term funding conditions, it also exposes banks to greater interest-rate volatility. The shift signifies an emerging "LPR+DR" framework, offering banks a wider range of benchmarks for loan pricing depending on borrowers' specific needs. Borrowers, in turn, must be prepared to manage rate volatility.

Commercial banks are actively testing this mechanism. For instance, China Merchants Bank extended a one-year working-capital loan to a private technology company using the average DR over the past three months, with rates reset every three months. Bank of Shanghai issued a 50 million yuan DR-linked working-capital loan to a chemical manufacturer, while Industrial and Commercial Bank of China's Shenzhen branch introduced a 50 million yuan floating-rate facility for a private company in a strategic emerging industry.

China Minsheng Bank launched its first DR-benchmarked loan under a free-trade account in Shanghai on August 3, extending this approach to cross-border and offshore financing. Bank of China recently introduced the market's first DR-linked loan with daily repricing, reflecting market conditions with each daily reset, creating a closer link between corporate borrowing costs and short-term money-market rates.

The People's Bank of China (PBOC) aims to further refine its monetary policy operating framework, targeting steady and orderly improvements in short-term money-market rates. The central bank's governor, Pan Gongsheng, announced in June that Beijing would further develop a price-based short-term interest-rate framework, aligning with international practices.

The US has shifted to the secured overnight financing rate (SOFR), while the UK uses the sterling overnight index average (Sonia), both of which reflect money-market transactions instead of bank quotations.