China's Central Bank Tightens Real Estate Lending

• The Circular provides that a developer's equity interest in a real estate project must account for at least 30% of the total capitalization of the project. Although the 30% equity requirement has been a long-standing PBOC stipulation, it has previously been subject to widespread abuse.

• In order to address the problem of construction companies “re-lending” their credit lines to developers, the Circular provides that contractors in real estate projects may only use working capital loans to purchase construction equipment. If a construction company applies the proceeds of a working capital loan to other uses, the bank must recall the loan and notify other banks, which must also refrain from lending to the contractor.

• In order to relieve borrowers of excessive interest costs, banks may only make residential mortgage loans once property construction is complete. The loan amount for residential mortgages may be no more than 80% of the purchase price of the premises.

• Mortgage loans for individual commercial units are limited to 60% of the purchase price, and to terms not exceeding 10 years.

• Banks must apply preferential interest rates to mortgage financing of home purchases for residential use. Higher rates, published by the PBOC, must be applied to investment-related and other housing loans.

Unlike other countries, where real estate is often financed through equity or bond offerings, bank financing for minimally capitalized developers has long been the norm in China, with 60% of the capital for real estate development coming from bank loans.⁴ According to China's National Bureau of Statistics, real estate loans at Chinese banks amounted to approximately US$216 billion as of April 2003, or 17.6% of total outstanding loans, representing year-on-year growth of approximately 33%. As much as 80% of the total outstanding real estate loans have been granted in the past two years. As China's banks ready themselves for foreign competition and potential listings on overseas stock exchanges, PBOC intervention in a runaway real estate lending market may prove sensible, and even vital.

To date, there has been significant uncertainty among market participants regarding the impact of the PBOC's Circular. At first, some speculated that mainland banks would be forced to recall up to US$22 billion in outstanding working capital loans.⁵ So far, however, banks appear to be applying the Circular on a prospective basis only. Standard & Poor's, which provides ratings for a number of mainland banks, was quick to praise the Circular as “a positive step towards curtailing runaway credit growth”.⁶ At least one large real estate developer in Beijing has suggested that PBOC lending restrictions may lead to consolidation in the market as smaller, more thinly capitalized players are squeezed-out or forced to merge with competitors.

In the meantime, a number of foreign investment firms have been looking at ways to fill the financing gap the Circular might create for China's real estate developers. Some have even suggested that PBOC intervention may be an impetus for REITs, securitizations, and other sophisticated real estate financing techniques in China.

In its August policy statement, the State Council acknowledged that real estate has become a “pillar industry” in China's economy.⁷ The key test for the State Council and the PBOC will be whether China can strike a delicate balance between imposing prudent lending standards and sustaining growth in real estate and other key sectors. In another recent move, the PBOC announced a 1% increase in bank reserve requirements to 7% of deposits, effectively increasing interest rates in China. Perhaps the PBOC is taking a lesson from central banks in other countries that have experienced market “bubbles” in recent years. It appears the PBOC wants to avoid doing too little, too late.

Endnotes

1 Yin Fa [2003] No. 121.

2 While the Circular refers only to domestic banks, it is unclear whether the PBOC will apply the same policies to foreign-funded banks (FFBs) in the future. FFBs include wholly foreign-owned banks, Sino-foreign joint venture banks with foreign investment exceeding 25%, and branches of foreign banks in China. At present, FFBs are only permitted to conduct limited renminbi (RMB) businesses with foreign-invested enterprises (FIEs) within specified locations, and are not permitted to grant RMB loans to Chinese enterprises (other than FIEs) for real estate or other purposes.

3 State Council, Promoting the Continuous Healthy Development of the Real Property Market Circular (the Circular), promulgated on August 12 2003.

4 Based on PBOC estimates reported in various news sources within China.

5 See “China May Recall $168b in Loans,” South China Morning Post, June 24 2003.

6 See “HK Regulators Aware of Thrent of Overlending,” Asia Pulse, June 27 2003.

7 See Section 1 of Article 1 of the Circular.

The authors would like to thank Nick Ma of CB Richard Ellis in Beijing for his invaluable comments on this article.