The decision by China's central bank to cut benchmark lending and deposit rates is a welcome policy response to the nation's recent lackluster economic performance, said Deutsche Bank's chief for the Greater China area.

The move should help lift demand for loans and effectively reduce funding costs for corporations, he said.

"The commencement of interest rate liberalization should also, in the longer term, help improve the allocation of financial resources, although it may generate short-term pressure on banks' NIM (net interest margin), " Ma Jun told China Daily in an email.

The People's Bank of China decided to cut both the one-year benchmark lending and deposit rates by a quarter of a percentage point, and it also reduced benchmark rates for other maturities. The policy, effective Friday, sets a one-year benchmark deposit rate of 3.25 percent and a one-year benchmark lending rate of 6.31 percent.

The central bank also announced that commercial banks are now allowed to set lending rates at or above 80 percent of the benchmark rates, whereas the lower boundary was previously 90 percent.

The new policy permits banks to set deposit rates at levels at or below 1.1 times the benchmark rates, while deposit rates were never allowed to exceed the benchmark in the past.

"The direction of these policy moves is generally in line with our expectations. The interesting difference is that, instead of an asymmetric benchmark rate cut, which we thought makes more immediate sense, the central bank decided to symmetrically cut the one-year benchmark rates, but it introduced effective asymmetric rate changes by expanding the interest rate bands."

"The net impact on banks' NIM and on corporations should be similar to that of an asymmetric benchmark rate cut."

Ma said that government planners acted preemptively, anticipating a negative outlook in the forthcoming release of May's economic data on Saturday. Industrial production and investment growth may remain weak, although year-on-year export growth may improve. CPI and PPI inflation should also decline further.

Their second rationale, he said, is that they believe a 25 basis point cut to lending rates can effectively reduce funding costs for many highly leveraged sectors and improve demand for loans.

"For example, a 25 basis points reduction in lending rates should boost the power sector's annual profit by about 7 percent. The positive earnings impact on property, transportation and raw materials sectors can also be significant, as they are also quite leveraged. The lending rate cut should also help lift demand for loans, at least marginally. Note that the weakness in loan demand has been a major downside risk to investment growth," he said.

Ma said banking analysts at Deutsche Bank believe that banks may bid up deposit rates immediately due to competition between banks for deposits and competition from wealth management products.

"In the extreme case of all banks pushing up deposit rates to 3.575 percent (the new cap) tomorrow while the lending rate only declines by 25 basis points in line with benchmark rate cut, the banking system's net interest margin should fall by about 19 basis points from the current 250 basis points," he said.

Ma added that another possibility is that, given the implicit state guarantee, larger banks do not need to raise deposit rates as much as smaller institutions, which are generally perceived as less safe by depositors. As a result, larger banks may gain market shares from smaller banks or outperform smaller banks due to less contraction in NIM.

Over the longer term, Ma said Deutsche Bank believes interest rate liberalization will provide the basis for more efficient financial resource allocation and form an important condition for China's capital account liberalization. These fundamental reforms will eventually improve the performance of the economy, according to Ma.

Ma said they believe that although the short-term impact of the central bank's decisions may hurt banks' margins, Deutsche Bank is optimistic about the prospects of the real economy if risks to investment growth are limited.

The policy will eventually help improve the efficiency of the economy through market-based pricing for financial resources.

"Highly leveraged sectors, such as power, real estate, transport and materials should benefit the most," Ma said.