It should widen the band for banks to float lending rates and "appropriately" free up deposit rates, the China Securities newspaper quoted a report by economists funded by the State Natural Science Foundation as saying.

China should reform the interest rate system this year by taking an opportunity created by less demand for capital by state firms and restrained lending by commercial banks worried about renewed risks, it said.

"The possibility of leading to a loss of control on bank interest rates is not big after appropriately relaxing controls on interest rates," it said.

China's central bank sets deposit rates for commercial banks. It also sets basic lending rates, though allowing banks some leeway in determining rates to their customers.

China should allow commercial banks and credit agencies to set a maximum 30 percent surcharge or discount based on the central bank's basic rates, the newspaper said.

At present, banks are entitled to a 10 per cent floating band in extending working capital loans, while banks and urban credit agencies were subject to a 20 per cent ceiling in lending to smaller firms, the newspaper said.

Reform would help foster "fair competition" among banks and other financial institutions and help create "balanced interest rates," it quoted the research group as saying.

"Deposit rates should also be permitted to floatappropriately," it said.The group said there was "still an objective need to lower interest rates" this year despite six per cent interest rate in the past three years. The newspaper disclosed no further details.