Entrusted loans (
The lender may be a government department, a public or private entity, or an individual.
Entrusted loans have seen flourishing growth since the issuance of the “Notice Concerning Issues in Relation to the Undertaking of Entrusted Loan Operations by Commercial Banks” (关于商业银行开办委托贷款业务有关问题的通知) by the People’s Bank of China, and have emerged as a key segment of the Chinese shadow banking sector.
Both parties to entrusted loans are required to be one of the following
– Private or public entities whose registration has been approved by the industrial and commercial administrative authorities;
– An other economic organisation (其他经济组织);
– An individual business (个体工商户);
– A natural person who possesses full capacity for civic acts.
Applicants are also required to have already opened a settlement account at a bank, while the source for the entrusted loan funds must be lawful, and the lender must possess independent allocation rights.
Risk in relation to entrusted loans
While entrusted loans have abetted the channelling of funds to the real economy in China’s state-dominated banking sector, concerns have arisen about the high levels of risks involved in this particular form of lending.
Key sources of risk for lenders when making entrusted loans are:
1.Lenders do not have adequate means of inspecting the projects for which funds will be used, as the lenders for entrusted loans are not financial institutions, and lack specialised departments to conduct project assessments. The creditor and debtor for entrusted loans are often affiliated companies, and whether or not the loan will proceed is more dependent on the level of association between the two parties.
2. Because lenders lack adequate means of determining the financial standing of the guarantor, the guarantees for entrusted loans are often mere formalities.
Examples of how entrusted loans can go awry
One example of how risk can arise during the process of entrusted lending could involve a Company A possessing idle funds, and a Company B having a project in need of capital.
Should Company A and Company B enjoy close relations, Company B may decide to borrow funds from Company A and Company A may agree to the request.
In order to expedite the lending process Company A may find a commercial bank and entrust it with the provision of the loan to Company B, while Company B finds a Company C that can serve as a guarantor for the loan.
The Company C that Company B enlists as a loan guarantor might be a shell company, however, leading to complete loss of Company A’s capital should the project for which funds were lent end in failure.
Another example might involve a Company A being a scarp metal importers, who approaches Company B for a loan due to an inadequate flow of funds. If Company B agrees, it will entrust a commercial bank with the provision of the loan to Company A.
Should international scrap metal prices rise and Company A sustain losses, it may be unable to repay the loan to Company B when it matures.