But experts are expressing concern the plan will spark fierce competition among commercial banks which are top heavy with bad loans.

The (PBOC), the central bank, has applied to the State Council, China's cabinet, for permission to widen next year the band for lending rates for small and medium-sized enterprises (SMEs), said a source close to the PBOC.

"A wider band for lending rates would allow financial institutions more flexibility in adjusting lending policies based on risk assessments, businesses and scales of debtors," said the source, on condition of anonymity.

The proposal is seen as an incentive to stimulate more lending to fund-strapped small businesses.

"The experiment to widen the floating band of interest rates is not targeted at the Big Four State banks," Dai Genyou, director of PBOC's monetary policy department, said previously.

"Widening the band of lending rates, and thus increasing profit margins for high-risk lending, is aimed at encouraging small and medium-sized commercial banks to increase financing for SMEs," said Dai.

PBOC statistics indicate loans granted to SMEs represent 43.6 per cent of loans by financial institutions nationwide. Up to 65.3 per cent of loans granted by financial institutions at the county level are to SMEs.

The proposal, if approved, would be the third major move by the central bank since 1998 to free lending rates for small businesses.

In October 1998, the bank allowed commercial banks, city co-operatives, to float lending rates for small businesses from 20 percent above the benchmark rate to 10 percent below the benchmark.

Prior to that, the rates were limited to 10 percent above the benchmark rate and 10 percent below the benchmark.

The move also allowed rural co-operatives to float lending rates for small businesses 50 percent above the benchmark compared with the original 40 per cent cap.

A PBOC regulation in September 1999 allowed commercial banks and city co-operatives to float lending rates for small businesses 30 per cent above the benchmark.

Despite these efforts, commercial banks have remained conservative lenders, considering SMEs borrowing have usually involved high risks but have cost no less than big financing projects.

Some analysts are concerned deregulation of interest rates will spark fierce competition among financial institutions and further deteriorate State-owned banks, which are laden with bad loans.

Earlier reports suggested an interest-rate-reform initiative involving all enterprises had been halted by fierce opposition from China's Big Four State banks, as they feared the reform could result in more bad lending and threaten their efforts to clean up bad loans.

Some volatile smaller commercial banks with mounting non-performing loans could even fail to survive the fierce competition, which could lead to new financial risks to China's transforming economy, said Li Yang, a financial expert with the Chinese Academy of Social Sciences.

Experts suggest the reform could also raise financing costs for companies, as the interest rate reshuffle would likely place pressure on the debt-laden enterprises.

PBOC Governor Dai Xianglong mapped out in 2000 a three-year timetable for liberalizing interest rates.

That plan included liberalizing interest rates of both the renminbi and foreign currencies - for both deposits and loans.

Following the liberalization of interbank offer rates in June 1996, and the introduction of the public bidding system for interest rates on treasury bonds, China liberalized foreign currency interest rates in 2000.

A pilot reform project is under way in eight rural credit co-operatives in five provinces. The co-operatives are allowed more flexibility in setting interest rates, with a maximum 30 per cent in deposits and 100 per cent in loans from the central bank's benchmark rates.

(Business Weekly December 24, 2002)