China allows interest rate swap trade on trial
(Shanghai Daily)
Updated: 2006-02-10 14:00

China will allow the transaction of interest rate swap on a trial basis as part of moves to offer more channels for companies and institutions to hedge against risks under a more market-driven interest rate system.

Commercial banks that are approved to trade financial derivatives will be able to trade interest rate swaps between themselves and their clients in the pilot program, the People's Bank of China said on its Website yesterday.

"The move is a natural outcome as China quickens reform on interest rate. The interest rate swap trading also meets the urgent demand for a risk management alternative in the interbank bond market," the central bank said in a statement.

Investors in China's money market are holding large amounts of fixed-rate bonds and bearing high interest rate risks, the central bank said.

The rate swap allows parties to exchange fixed payments for floating-rate payments or vice versa after signing an agreement.

The swap can help institutions lock risks and prevent future losses.

For instance, institutions which issued bonds at a floating rate can avoid losses when they exchange the floating rate for a fixed rate with banks, betting on an interest rate increase.

"The move signals a more market-oriented interest rate system in China," said Wu Yonggang, a Guotai Jun'an Securities Co Ltd analyst.

"Parties can enjoy their preferred interest rate after reaching agreement in the swap," he said. "It enables companies and banks to better manage their assets and liabilities."

The world's fastest-growing major economy has already taken several steps to liberalize a tightly-regulated interest rate system.

The central bank has given commercial lenders more leeway by removing the upper limit on the floating range in which they can charge lending rates. China raised its benchmark interest rates for the first time in October 2004 after nine years.

The one-year lending rate rose to 5.58 percent from 5.31 percent, the first loan rate rise since July 1995 after the interest rate increase. The one-year deposit rate rose to 2.25 percent from 1.98 percent, the first increase in the interest rate paid on savings since July 1993.

The central bank said it will gradually expand the pilot program and fully open the business after gaining experience from the trial.

There are now two types of swap in China - currency swap and interest rate swap.