CHINA is taking small steps toward a monetary framework that works through market-based rates, as the People's Bank of China wants a firm grip over credit conditions that have been weakened by the shadow banking system, said Standard and Poor's Ratings Services.

The shadow banking system, an informal system of financing often facilitated by Chinese banks, may finally lead the central bank to adopt a monetary framework that is centered around a market-based interest rate, said S&P's latest report.

Such framework will strengthen China's ability to sustain economic growth and attenuate economic or financial shocks over time. And the nation's current reliance on direct administrative measures impedes its ability to influence domestic financing conditions in important parts of the economy, it said.

However, it may also create several policy challenges for the government. The change could reduce bank profitability, especially at smaller institutions.

The accompanying uncertainty could also create more headwinds for near-term economic growth. And it could increase the volatility of short-term international capital flows, according to the report.

The PBOC announced Friday it would scrap the floor of lending rates except personal mortgage loans.