Member Article

In 2005, China’s State Administration of Foreign Exchange ("SAFE") released the Circular on Verification of Quotas for 2005 on Short-term Foreign Loans of Overseas-funded Banks ("Circular") and its Supplementary Circular on Questions Related to Renminbi Loans with Guarantees in Foreign Exchange ("Supplementary Circular", and together the "Circulars"). The Circulars are intended to facilitate the enforcement of loan registration requirements on renminbi loans with guarantees in foreign exchange. Prior to the enactment of the Circulars, banks had not been required to undertake any specific registration for renminbi loans with foreign exchange guarantees extended to foreign-invested enterprises. What are the Circulars about? Under the Circular, foreign-invested enterprises applying for renminbi loans with guarantees in foreign exchange should obtain a registration form with the relevant foreign exchange administration and abide by the registration procedures. The Circular also requires that the total balance of a foreign-invested enterprise’s renminbi and foreign exchange loans must not be larger than the difference between the enterprise’s total investments and registered capital if a foreign-invested enterprise wishes to apply for a loan. The Circulars provide that the verification of short-term foreign debt indicators of overseas-funded banks will be implemented in accordance with the requirements stipulated under the Administration of Foreign Debts of Foreign-invested Banks in China Procedures. During the verification, changes in the balance of all foreign exchange loan items of the overseas-funded bank within the previous two years shall be taken into account by the relevant foreign exchange administration. The foreign exchange administration will also look into the short-term foreign debt indicators of the bank after the adjustment in November 2004 and the actual balance of the short-term foreign debts at the end of the year. Lastly, the overseas-funded bank’s business development plan for the year 2005 will be scrutinised. The foreign exchange administration will exercise control over the total amount of the short-term foreign debts of the overseas-funded banks. In addition, the foreign exchange administration may adjust the foreign debt indicators. A principal reporting branch of an overseas-funded bank could also apply for a short-term foreign debt indicator with the foreign exchange administration at the place where it is located. The Circulars state that where overseas-funded banks operate in regions that have not been open to renminbi services, they may carry on to provide foreign exchange guarantees to renminbi loans extended to foreign-invested enterprises. Previous renminbi loans secured by foreign exchange will be handled in compliance with the People’s Bank of China, Improving the Administration of Renminbi Loans Secured by Foreign Exchange Circular, and subsequent registration will not be needed. What are the effects of the Circulars? On Foreign-invested Enterprises: Prior to the enactment of the circulars, a trading enterprise with small registered capital could secure loans even when the amount of the loan exceeded the difference between its total investments and registered capital. Under the circulars, however, trading enterprises would find it increasingly difficult to secure loans through guarantees of their parent firm overseas unless the enterprises increase their total investments to widen the difference between the two. On the other hand, the impact of the Circulars on enterprises with more capital would be relatively limited. On Overseas-funded Banks: The Circulars have a limitation effect on the credit expansion of overseas-funded banks. For instance, foreign-invested enterprises are now expected to meet the requirements on the difference between total investments and registered capital before they can apply for foreign exchange and renminbi loans. On the Banking Sector as a whole: In practice, the Circulars serve to limit the overall scale of the banks’ loans and control the risks facing the banks. Prior to the enactment of the circulars, there were practically no restrictions on the size of loans which could be secured by an enterprise and it was likely that individual enterprises would use part of the loans for other purposes. The result was that banks found it very difficult to control risks when part of the loans entered over-heated sectors. On the Pressure for Renminbi Revaluation: The Circulars have been regarded as a measure to release the pressure on renminbi revaluation. In the past, foreign investors have sought to secure renminbi loans through the guarantee of foreign exchange. However, the loans often enter the overheated sectors on the mainland and are not being used for their normal business purposes. Hence, it would not be surprising if large amounts of renminbi loans result in speculation in renminbi revaluation. To ease fears, SAFE has therefore imposed the loan registration requirements to restrict lending made to foreign-invested enterprises. Would the Circulars bring about real change? Some argue that the Circulars will have little effect in practice. This is because although an enterprise’s registered capital cannot be changed easily, a change in the total amount of investment is possible. As a result, an enterprise can widen the difference between its registered capital and total investments by increasing the amount of investments. Moreover, since it would apparently still be legal for foreign-invested enterprises to secure loans supported by the use of overseas letters of credit, regulators will find it hard to decide whether the use of the loans is reasonable. Lastly, foreign-invested enterprises have figured out alternate ways of securing loans through the use of guarantees other than foreign exchange. For instance, fixed assets or properties in the PRC could be used as guarantees to avoid the restrictions imposed by the Circulars. Conclusion On the whole, the SAFE Circulars have a limitation effect on foreign-invested enterprises and overseas-funded banks. At the same time, they serve to alleviate the risks facing the banking sector and ease somewhat the pressure on renminbi revaluation. However, it is arguable that the effect of the Circulars has yet to be ascertained since enterprises would still be able to secure loans from banks within the PRC via more flexible means.