Measures for the Administration of Debt Provisioning by Financial Institutions

(Issued by the Ministry of Finance on May 25 2005 and effective as of July 1 2005.)

Cai Jin [2005] No.49

PART ONE: GENERAL PROVISIONS

Article 1: These Measures have been formulated to guard against operational risks, strengthen the ability of financial institutions to withstand risk, accurately calculate gains and losses and promote the stable operation and healthy development of financial institutions.

Article 2: For the purposes of these Measures, the term 'financial institution' means an enterprise, other than a financial asset management company, that engages in finance business, such as a policy bank, commercial bank, trust and investment corporation, finance company, lease-financing company and urban or rural credit cooperative, etc. approved by the China Banking Regulatory Commission and registered in the People's Republic of China.

Article 3: For the purposes of these Measures, the term 'debt provision' means a reserve for debts set aside by a financial institution for debt and equity assets on which it bears risks and could incur losses, and includes general provisions and relevant asset impairment provisions.

For the purposes of these Measures, the term 'general provision' means a provision allocated at a certain percentage from a financial institution's net profit to make up as yet unidentified potential losses.

For the purposes of these Measures, the term 'asset impairment provision' means a provision allocated by a financial institution for the portion that the estimated recoverable amount of a debt asset or equity asset falls short of the book value thereof, and is used to make up a particular loss, and includes loan loss provisions, bad debt provisions and provisions for the impairment of long-term investments. The term 'loan loss provision' means a provision allocated by a financial institution against anticipated loan losses that could be incurred in respect of various loans. The term 'bad debt provision' means a provision allocated by a financial institution against anticipated bad debts arising in respect of various receivables.

PART TWO: DEBT PROVISIONING

Article 4: A financial institution shall make allocations to a debt provision for assets in respect of which it bears a risk and could incur losses, specifically including loans (including such loans as mortgages, pledges, guarantees, etc.), bank card overdrafts, discounts, credit advances (including bank acceptance advances, letter of credit advances, guarantee advances, etc.), documentary drafts for imports and exports, equity investments and debt investments (excluding securities investments that use the lower of cost and market method or fair value method to determine the period-end value or investments in the principal and interest of purchased sovereign bonds), inter-bank borrowings (loans), inter-bank deposits placed, interest receivables (excluding loans and interest receivable on inter-bank loans), dividends receivable, leasing receivables, other receivables, etc.

Allocations shall also be made to a debt provision for foreign loans for which a financial institution acts as the onlender and bears the responsibility for repaying the loan to the relevant foreign lender, including assets such as loans from international financial organizations, foreign buyer credit, foreign government loans, unconditional loans from the Japan Bank for International Cooperation and mixed loans from various foreign governments.

No allocation need be made to a debt provision for assets such as entrusted loans on which a financial institution bears no risk.

Article 5: At the end of each accounting year, a financial institution shall make allocations to its general provision at a certain percentage of the balance of assets on which it bears risks and could sustain losses. The percentage allocated to its general provision by a financial institution shall be determined by comprehensively considering factors such as the risks it faces, and, in principle, the balance of a general provision shall not be less than 1% of the year-end balance of its risk assets. The general provision shall be allocated and managed centrally by the head office of the financial institution.

A financial institution shall review its various debt and equity assets on a quarterly basis, analyze their recoverability and, in accordance with the principle of prudence, reasonably estimate the losses its various assets may generate. It shall make allocations to its loan loss provision for those loan losses it could incur, to its bad debt provision for those bad debt losses it could incur and to its provision for impairment of long-term investments for long-term investment losses it could incur.

Article 6: The scope for allocations to a financial institution's loan loss provision shall be those loans on which it bears risks and could incur losses (including such loans as mortgages, pledges, guarantees, etc.), bank card overdrafts, discounts, credit advances (including bank acceptance advances, letter of credit advances, guarantee advances, etc.), documentary drafts for imports and exports, inter-bank loans, finance leasing receivables, etc.

Loan loss provisions include specific provisions and special provisions.

The term 'specific provision' means a provision allocated by a financial institution based on the extent of its loan losses after a risk classification of its loan assets based on the Guiding Principles for the Classification of Loan Risk and used to make up specific losses. The percentage to be allocated to a specific provision shall be reasonably determined by a financial institution based on the extent of the loan asset risk and the possibility of recovering such loans.

A financial institution may make allocations to its specific provision by making reference to the following percentages:

2% allocated for those loans in the special mention category, 25% for those that are in the substandard category, 50% for those that are in the doubtful category and 100% for those that are in the loss category. The percentage allocated to the loss provision for those classified as substandard or doubtful may fluctuate up or down by 20%.

The term 'special provision' means a provision allocated by a financial institution for loans extended to a specific country, region or industry. The specific percentage to be allocated to such a provision shall be reasonably determined by the financial institution based on the extent of the loan asset risk and the possibility of recovering such loans.

Article 7: The scope for allocations to a bad debt provision shall be inter-bank deposits placed, bond interest receivables, dividends receivable, operating lease receivables, other receivables, etc.

A financial institution may refer to the Guiding Principles for the Classification of Loan Risk when classifying the risk underlying assets in respect of which allocations are to be made to its bad debt provision and shall determine the percentage to be allocated thereto based on the results of the risk classification and with reference to the percentage for allocations to a Specific Provision for loans. When determining the percentage to be allocated to its bad debt provision, a financial institution shall reasonably estimate the same based on its past experience, the actual financial position and cash flow of the debtor and other such relevant information.

Article 8: The scope for allocations to a provision for the impairment of long-term investments shall be equity investments and debt investments (excluding securities investments that use the lower of cost and market method or fair value method to determine the period-end value, or investments in the principal and interest of purchased sovereign bonds).

The determination on whether or not to make allocations to a provision for diminution in the value of long-term investments for which a market value is available may be based on the following indications:

(1) the market value has remained below the face value for two consecutive years;

(2) trading in the investment has been suspended for one year or more;

(3) the investee suffered serious losses during the year in question;

(4) the investee has made losses for two consecutive years; or

(5) the investee is undergoing screening and rectification or liquidation, or another indication that it cannot sustain operations manifests itself.

The determination on whether or not to make allocations to a provision for the impairment of long-term investments for which no market value is available may be based on the following indications:

(1) changes in the political and legal environment that have an effect on the operations of the investee, e.g. the issue or amendment of taxation, trade or other such regulations that could cause the investee to suffer a large loss;

(2) a change in market demand for the merchandise supplied or services provided by the investee due to its products falling out of fashion or a change in the preference of consumers, thereby causing a severe deterioration in the investee's financial position;

(3) a material change in the production technology, etc. in the investee's industry, resulting in the investee losing its competitiveness, thereby causing a serious deterioration in its financial position, e.g. it is undergoing screening and rectification, liquidation, etc.; or

(4) other circumstances evidencing that the investment can essentially no longer generate economic benefits.

Article 9: A financial institution must timely make allocations to its debt provisions in full based on the extent of the risks underlying its assets. If it fails to make sufficient allocations to its debt provisions, it may not distribute its after-tax profit.

Article 10: Within 30 days of the end of each quarter, the head office of a financial institution and its branches and sub-branches shall provide information on their allocations to their debt provisions to the competent financial department (including information on the division and classification of assets for which allocations to their debt provisions were made, the method of evaluating the risks underlying their assets, the percentages allocated to their debt provisions and changes thereto) and provide information on the change in the balance of the relevant debt provisions by category of asset (at the beginning of the quarter, allocations during the quarter, reversals during the quarter, write-offs during the quarter and quarter-end figures).

Article 11: The financial control offices of the Ministry of Finance in the regions shall be responsible for the oversight of the allocations to debt provisions by the branches and sub-branches in their regions of financial institutions that are managed by the central government. If a branch or sub-branch has failed to allocate a sufficient amount to its debt provision in accordance with provisions, the financial control office shall put a halt thereto and order rectification.

PART THREE: FINANCIAL TREATMENT

Article 12: The general provision allocated by a financial institution shall be treated as a distribution of profit. The general provision is a constituent of the owner's equity.

Article 13: The provision for the impairment of relevant assets allocated by a financial institution shall be treated as part of the profit and loss for the period in question. If the quality of assets for which allocations to a provision for its impairment has been made increases, a reversal shall be made within the scope of the allocated provision for the impairment in value, and a positive increase in the profit and loss for the period in question resulted.

Article 14: Once compliant asset losses have been written off after approval, the amount thereof shall be set off against the allocated provision for the impairment of the relevant assets. With respect to on balance sheet interest receivables that have been written off after approval, if they have already been included in the profit and loss, they shall be treated as interest income set-off, regardless of whether the principal or interest is past due.

If asset losses that have been written off are later recovered, the provision for the impairment of the relevant assets that have been written off shall be reversed and the portion in excess of the principal, including both recovered on and off balance sheet interest receivables, shall be counted as interest income. The reversed asset impairment provision shall be treated as a positive increase in the profit and loss for the period in question.

Article 15: Allocations to an asset impairment provision shall be made in the original currency, i.e. allocations shall be made in renminbi for renminbi assets and in foreign currency or an equivalent amount in US dollars for foreign currency assets. The provisions for the impairment of renminbi assets and foreign currency assets shall be accounted for and represented separately.

PART FOUR: SUPPLEMENTARY PROVISIONS

Article 16: Financial institutions may formulate specific measures based on these Measures and submit the same to the competent finance department for the record.

Article 17: These Measures shall be effective as of July 1 2005. In the event of a conflict between these Measures and previous relevant provisions, these Measures shall prevail.