Background
In order to regulate the working capital loan business, China Banking Regulatory Commission ("CBRC") released the Provisional Measures on the Administration of Working Capital Loans (hereinafter referred to as the "Working Capital Loan Measures") on 12 February 2010, which came into force on the date of its promulgation.The Working Capital Loan Measures, together with the Provisional Measures on the Administration of Personal Loans promulgated by CBRC on the same date, the Guidelines for Project Finance Business and the Provisional Measures on the Administration of Fixed Assets Loans each promulgated by CBRC in 2009, were aimed to preliminarily establishing and improving the loan business regulation framework for the banking institutions.
Overview of the Working Capital Loan Measures
"Working capital loans"mentioned in the Working Capital Loan Measures mean loans, in RMB or in foreign currency, granted by the lender to the borrower to finance the turnover of the borrower's routine production and operation.
The Working Capital Loan Measures specify regulatory requirements in respect of loan application acceptance and investigation, risk appraisal and approval, signing of contract, disbursement and payment, and post-lending management to regulate the loan business process, and constitute a comprehensive modification to and improvement on the existing regulations on the working capital loan business.
For those lenders who violate the Working Capital Loan Measures, penalties will be imposed accordingly.Moreover, the Working Capital Loan Measures also require lenders to prepare their own sets of internal administrative rules and operation procedures based on the provisions promulgated.
Key Observations
1. Calculation of working capital loan demand
In order to prevent any misappropriation resulting from the disbursement being in excess of the borrower's actual working capital loan demand, the Working Capital Loan Measures require lenders to reasonably calculate the borrower's working capital demand and prudently determine the amounts of total credit and of the specific facilities that are to be made available to the borrower.No working capital loan in excess of the borrower's actual demand shall be granted.
Moreover, a "reference model"is attached to the Working Capital Loan Measures setting forth the approach to calculate loan demands.According to the model, working capital loan demands shall be determined based on the difference between the working capital required for the borrower's routine production and operation and the borrower's existing working capital.It is worth noting that the sales revenue and profit rate from the previous year are factored into the model, thus such calculation approach cannot be applied if the borrower is a new-established enterprise or the loan is to finance a project during the construction period.Further clarifications from the regulator are needed when circumstances like these happen.
2. Payment of loan proceeds
The Working Capital Loan Measures provide that the payment method and standard of the loans may be agreed between the parties given that the liquidity loans shall be paid frequently, its turnover is quick and the cost for payment control will normally make it inefficient.The lender may, by taking into consideration of the industry features, operation size, management level and creditworthiness of the borrower and the loan type, reasonably determine the payment method of the loan and the threshold amount above and beyond which a pay-on-trust approach would become mandatory(1).Moreover, the Working Capital Loan Measures require the "pay-on-trust"rule be applied in principle if the transactions have certain special characteristics as set forth in the Working Capital Loan Measures.
3. Account management
Despite that the account control mechanism is from time to time seen in long term fixed assets loans and project financing cases, it is the first time it be required as well for working capital loans.The Working Capital Loan Measures have provisions that require the designation of a special collection account and the signing of an account management agreement.In addition, the lender shall be entitled to require prepayment of loans by reference to the receivables collection progress of the borrower.
If the foregoing requirements are strictly implemented, it may mean that the borrower shall designate a separate special collection account and enter into a separate account management agreement every time the borrower borrows a working capital loan from a bank.The feasibility remains to be tested. Besides, as some working capital loans do not have a dedicated repayment source, and further clarifications from the regulator are needed on how to designate special collection account or enter into account management agreement in such cases.
4. Loan period and extension
The Working Capital Loan Measures allow lenders to determine the term of a loan reasonably in accordance with the operation size and the cyclicality features of business of the borrower.For term extension requests, lenders shall review the reason for the change of the corresponding assets turnover period and the actual needs of the borrower to determine whether to grant such extension and shall set the length of such extension reasonably.
The Working Capital Loan Measures do not set out specific requirements on loan terms and extension length, although provisions appeared in a circulated craft requiring that the loan term shall not exceed 3 years.According to the relevant regulations promulgated long ago by the People's Bank of China ("PBOC"), however, terms for working capital loans shall not exceed 3 years and certain restrictions are in place for extensions.Confusion might be brought about to the industry by the discrepancy between the PBOC rules and the newly released Working Capital Loan Measures.
5. Penalties for violation
The Working Capital Loan Measures provide that the regulator may impose various penalties on lenders if they carry out the working capital loan business in violation of the provisions.In particular, if a lender fails to sign the loan contract with the borrower in accordance with the Working Capital Loan Measures or fails to take effective remedies against the borrower in case the borrower violates the contract, the lender will incur to itself penalties.Therefore, banks need to carefully prepare their loan documents so as to stay in line with the regulatory requirements, and to prudently set out the terms of the contact and improve their business supervision.
Conclusion
The Working Capital Loan Measures reflect the efforts by the regulator to monitor the use of working capital loans.Banks need to prepare their own administrative rules and operation procedures in accordance with the new rules and carry out the preparation work with respect to the organization structuring, information system and standard-form contracts amendments.Moreover, banks also need to consider or consult with the regulator on how to implement some of the provisions that begets further clarifications, such as how to calculate the working capital loan demand, how to establish and manage the special collection account and how to determine the loan period and extension standard of the working capital loan period.
Notes:
(1) "pay on trust"means that the lender directly pays the loan proceeds to the relevant counterparty of the borrower in accordance with the purpose stipulated in the loan contract.
Contacts
For further information on the matters covered in this newsletter, please contact:
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Liu Zhigang
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China
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Email: liuzhigang@kingandwood.com
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Shanghai 200031
China
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Email: jackwang@kingandwood.com