RMB Borrowing - A Market with Unrealized Potential

Article 17 of the FIFI Regulations sets out the scope of business of a foreign investment bank, a branch of a foreign bank and a joint venture bank. The lending of RMB debts is not mentioned in Article 17 as part of their "scope of business". However, "approved domestic currency business" is allowed under Article 17. In other words, a foreign bank has to be "approved" before it can carry on RMB business. As at the date of writing this article, there are more than 30 foreign banks that have obtained licences to conduct RMB business.

Restrictions on size of RMB loans granted by FIFIs

The PRC Commercial Banking Law (中华人民共和国商业银行法) (promulgated May 10 1995, the Commercial Banking Law) is of general application to both FIFIs and other commercial banks in the PRC. Article 39 provides that when granting a loan, a bank shall be subject to the following debt-equity ratio:

(1) capital adequacy ratio shall not be lower than 8%;

(2) the loans to deposits ratio shall not exceed 75%;

(3) the liquid asset to liquid liability ratio shall not be lower than 25%;

(4) the ratio of loans granted to the same borrower to the balance of capital of the bank shall not exceed 10%; and

(5) other regulations of the PBOC concerning the administration of debt-equity ratio.

There exist no other regulations from the PBOC concerning further requirements on debt-equity ratios issued pursuant to (5) above. However, the People's Bank of China Notice Concerning Expansion of RMB Business by FIFIs in Shanghai and Shenzhen (issued in 1999, no. 243, the 1999 Notice) provides that the total amount of RMB loans granted by the relevant branch of a foreign bank in the PRC shall not exceed 50% of the total amount of its foreign currency loans.

The Borrowers

Pursuant to the Lending General Provisions, PRC legal persons (including FIEs) can borrow in RMB from Chinese commercial banks without any prior approval from government authorities.

Term and Extension

Article 11 of the Lending General Provisions provides that the term of a loan for one's own account shall generally not exceed 10 years. A "loan for one's own account" (as distinguished from entrusted loans or loans designated by the State Council, both of which commonly involve government intervention), is a loan granted on one's own initiative using funds raised by lawful means, the risk of which shall be borne by the lender, and the principal and interest of which shall be collected by the lender. Loans with a term exceeding 10 years shall be reported to the PBOC for record. The term of a loan shall be determined between the lender and the borrower according to the borrower's production or business cycle and repayment capability and the lender's ability to provide funds and shall be stated clearly in the loan agreement.

More specifically on working capital loans, Article 6 of the Notice Concerning the Reasonable Ascertaining of Term for Working Capital Loans (promulgated October 6 1997, the Notice on Term) provides that a medium-term working capital loan should have a term of one to three years (excluding one year but including three years), and such loans should be granted to corporate borrowers having normal production and operation, especially those which are reputable and have larger production capacities. Article 4 of the Notice on Term provides that short-term loans should be for a term of three months to one year (excluding three months but including one year), and should be granted where a corporate borrower has cash flow needs. Unfortunately, the legislation has not set out any scientific test on how a borrower may qualify as one which is "reputable and have larger production capacities", as opposed to one with "cash flow needs". To complicate things further, Article 10 of the BOC Procedures provides that the term for working capital loans may not exceed 12 months (that is, for loans from the BOC).

Article 12 of the Implementing Rules to the BOC Procedures (promulgated October 20 1988, the BOC Implementing Rules) provides that the calculation of the term of a loan begins on the day the loan agreement takes effect (not when the availability period begins or when first drawdown takes place), and ends on the day contractually agreed by the parties as the final repayment date of all principal, interest and fees.

Article 12 of the Lending General Provisions provides that the term of a loan may be extended. Extensions of the term of a short-term loan may not cumulatively exceed the original term of the loan; extensions of the term of a medium-term loan may not cumulatively exceed half of the original term of the loan; and extensions of the term of a long-term loan may not cumulatively exceed three years. These restrictions exist to stop the practice of cashless rolling-over of what are effectively non-performing loans so that they never have to be accounted for as such. They can however present difficulties for borrowers who are, for genuine reasons, seeking long term revolving facilities.

Interest Rates

Article 13 of the Lending General Provisions provides that the lender shall specify in the loan agreement interest rate in accordance with the maximum and minimum "lending interest rates specified by the PBOC". The "maximum" and "minimum" may be found in Rule 4 of the People's Bank of China, Ten Rules Concerning Prohibition Against Arbitrary Increase in Interest Rates for Deposits and Loans (promulgated August 21 1993, the Ten Rules), which provides that the interest rate for working capital loans shall be within the range of 90% to 120% of the "interest rates as specified by the PBOC". Rule 3 provides that the interest rate for a fixed capital loan should be capped at the "interest rate specified by the PBOC".

The most recently published "rates specified by the PBOC" is found in Schedule 2 of the People's Bank of China, Notice Concerning Decrease in Interest Rates for Deposits and Loans (promulgated June 9 1999, the PBOC Notice on Interest Rates), which we include below:

Default Interest

Article 6 of the PBOC Notice on Interest Rates specifies default interest rate to be a daily rate of 0.021% (annualised at 7.56%). The 90% to 120% buffer applicable to the interest rate for working capital loans does not appear to apply to default interest. It also appears the 0.021% daily rate specified by the PBOC is not a cap on default interest rate, but rather a statutory rate which cannot be contracted out of. If this rate were purely for the sake of protecting the "unsophisticated" borrowers against exorbitant rates at least the parties should have the option to contractually agree to a lower figure.

Contents of Loan Agreement

Article 29 of the Lending General Provisions provides that a loan agreement shall stipulate:

(1) type of loan;

(2) purpose of loan;

(3) amount;

(4) interest rate;

(5) term;

(6) repayment method;

(7) rights and obligations of the borrower and lender;

(8) liability for breach of contract; and

(9) other matters as the two parties may consider necessary.

There are additional requirements in this respect in the People's Bank of China, Syndicated Loans Tentative Procedures (promulgated October 7 1997, the Syndicated Loans Procedures) and the BOC Implementing Rules. However, they are all silent on how the omission of any required information will impact the validity and enforceability of a loan agreement. Article 61 of the PRC Contract Law (中华人民共和国合同法) (promulgated March 15 1999, the Contract Law) provides that in case the terms of a contract are unclear, implications can be made from the context of the clauses and by customary practice. In other words, the mere fact of omission of any required information should not render the contract void.

Commitment Fees and Agency Fees

Commitment fees and agency fees in relation to syndicated loans granted by PRC branches of foreign banks are expressly permitted in the 1999 Notice. Each of such fees is subject to a cap of 0.3% of the loan amount. This is an improvement from Article 21 of the Syndicated Loans Procedures that provides that member banks of a syndicated loan shall not levy any charges other than interest on the borrower. However, it still remains to be clarified whether other commonly
levied fees, such as front-end fees or non-utilisation fees, can be collected.

Stamp Duty

Agreements for interbank lending are not subject to stamp duty. Otherwise, parties to an RMB loan agreement are subject to stamp duty of 0.005% of the loan amount. Article 8 of the PRC Stamp Duty Tentative Regulations (promulgated August 6 1988) provides that each party shall be fully responsible for the payment of stamp duty in relation to its own copy of the agreement. In practice the obligation to pay stamp duty on the lender's copy is often passed onto the borrower. Whether or not such contractual agreement to shift the responsibility on the borrower is legally valid and enforceable is another question.

Governing Law

In theory, under Article 126 of the Contract Law, the parties to a contract involving foreign interests may choose the law applicable to the settlement of contractual disputes. For this purpose, it is commonly understood that branches of foreign banks in the PRC will be regarded as "foreign parties" and contracts to which they are party should qualify as contracts "involving foreign interests". It follows then that where the lender is the PRC branch of a foreign bank, the parties to an RMB loan agreement should be free to choose foreign law as the governing law and to submit to the jurisdiction of foreign courts. However, in practice, since there is currently no reciprocity of enforcement of judgments between mainland China and HKSAR, foreign banks might wish to make PRC the express governing law and to provide for submission to the non-exclusive jurisdiction of the courts of the PRC so as to facilitate enforcement against a PRC borrower.

Conclusion

There is a real call for clarification of some of the existing legislation and for restrictions to be lifted, especially given the increase in appetite for RMB borrowing. It is clear that there is a ready pool of both potential lenders and potential borrowers, all that is required is for the current system to become less restrictive and more transparent.

Endnote:

1 Statistical Communique of the People's Republic of China on the 2000 National Economic and Social Development, National Bureau of Statistics, People's Republic of China, February 28 2001.