From cover, issue no. 365, April 28, 2008
Translated by Zuo Maohong
Original article: [Chinese]

To prevent abuses of loans in business transactions, China's banking watchdog is expected to order banks to release loans directly into the payees' accounts instead of to the borrowers'.

Under current Chinese regulations, when a company takes out a loan to pay a creditor, the loaned funds would be transferred into its bank account.

However, if the new rules by the China Banking Regulatory Commission (CBRC) come through, this loan would instead be deposited into the creditor's account directly.

The new rulings will adhere to the principle of a beneficiary payment system, aiming to curb companies from abusing bank loans and channeling the money into speculative investments.

Targeting Loan Abuses
The EO learned that the Commission had started drawing up "three regulations and one guideline" related to liquidity loans, fixed asset loans, individual loans, and project financing. The core objective of the rulings was to introduce the "beneficiary payment principle".

According to an official from the Commission, the work had started last year,and after several rounds of gathering feedback from industry players, the draft was ready to be sent for a second review by the Commission's policy and regulation department.

The official said the new rulings were intended to be implementated within this year, but he added: "There might be some changes after the review, so it has not been decided yet how and when exactly to launch the rulings."

A source from a commercial bank said the new principle targeted curbing "rampant" abuses of loans, adding it would be a significant reform for the loan management system.

Stimulated by hot real estate and stock markets, misappropriated bank loans had been on the rise, threatening the quality of banks' assets and creating bubbles in both markets, said the source.

In 2005, China Everbright Bank's Shanghai branch was found to have illegally invested 25 million yuan of credit into the stock market. In 2007, the Commission disclosed that eight banks had used a total of 2.5 billion yuan of credit for real estate and stock market investments.

"Those exposed cases are only the tip of an iceberg. Generally, half of the individual consumption loans at present may be used for other purposes, let alone loans to companies," the above source said.

In response, the Commission issued a notice in 2006 on risk management for transactions between financial institutions and securities firms. Since then, it also made numerous demands for banks to thoroughly investigate abuses in loans usage.

However, industry sources said such efforts were to no avail, as the banks could not effectively supervise the loans after the borrowers made several inter-bank transfers.

Beneficiary Payment Principle
Under the "beneficiary payment principle", a borrower should submit related contracts and the intended payee's account to the bank concerned. The loan would be released to the payee with the borrower's permission, an official from the Commission told the EO. Meanwhile, the bank would issue a "loan certificate" to the borrower.

In fact, the principle had been in application in some areas, according to a source in the industry. He gave the example of home mortgages, whereby the loaning bank would sign a loan contract and a payment authorization document with the borrower.

The approved loan would then be deposited into the borrower's account first for a short while but almost immediately the money would be transferred to the developer's account.

In addition, banks such as the Bank of China and the Industrial and Commercial Bank of China had also introduced a "capital flow supervision" mechanism on clients deemed to have low credibility. Under the mechanism, the client concerned was required to produce corresponding contracts and payment certificates before the bank would release payment.

In the previous applications, the source concluded that a loan was still required to go to the borrower first and then delivered to the intended payee; while the new principle under draft would simply skip the borrower's account.  

However, there remained difficulties in implementing the new rules efficiently, especially with verifying the legality of contracts between companies.

According to the above source, a bank could reign in its borrower based on terms and conditions stipulated in the loan contract, but it could not supervise the borrower's business contracts with other companies.

He said the end-receiver could be a company located a thousand miles away, and using the service of another bank. This made it difficult for the loan giving bank to assess clients' contracts and credits, he added.

Moreover, if the borrower had transferred the money to other banks, the loan giving bank would no longer have the right to examine the receiver's account or freeze it, he added.