What is an Entrusted Loan?
An entrusted loan is a lending arrangement organized by an agent bank between borrowers and lenders. In an entrusted loan, the agent bank is considered the trustee and the company providing the funds is considered the trustor. The trustee is responsible for the collection of principal and any interest, for which it charges a handling fee, but it is not supposed to assume any of the loan risks.
How Does an Entrusted Loan Work?
Entrusted loans have been most commonly issued in the People's Republic of China, which restricts direct borrowing and lending between commercial enterprises. The loans offer companies with idle cash the chance to earn some interest income on their money by allowing the agent bank to lend out those funds. The companies retain the right to decide whom the agent bank can lend the funds to. The People’s Bank of China, the nation’s central bank, started to allow entrusted loans in 2001.
The introduction of entrusted loans made it possible for companies operating in China, including those owned by the state, to improve their liquidity. However, entrusted loans were not as transparent as loans made in other developed countries. For example, entrusted loans were not included in the balance sheets of the agent banks because the banks, in theory at least, did not assume any of the credit risk. However, the exclusion of these loans from their balance sheets can hide the risks faced by the agent banks if the borrowers are unable to repay. This lack of transparency also made it more difficult to judge whether the country's economy was overheated or over-leveraged, as well as whether the quality of companies obtaining credit through these arrangements was holding steady or declining.
Entrusted loans, most common in China, use banks as an intermediary between borrower and lender.
China Issues New Entrusted Loan Rules
As a result of all these concerns, the Chinese government clamped down on the loans and the banks that made them possible in early 2018. In an official statement on its state-run website, the Chinese government acknowledged that "the entrusted loan business has grown fast and played a positive role in serving the real economy." However, it added, "Entrusted loans have played a major role in China’s shadow banking, which takes place outside the regulatory scope and remains a key source of risk to financial stability following years of rapid growth."
The new rules, issued by the China Banking Regulatory Commission (CBRC), stated that commercial banks must not provide guarantees or get involved in decision-making for these loans. Additionally, entrusted loans cannot be used for investments in bonds, derivatives, asset management or equities. Banks are not permitted to put their own money – or any funds that they manage – into entrusted loans. The CBRC cited "certain potential risk hazards," including the entrusted loan sector's rapid growth and its prior lack of government regulation, as the reason for the tightened rules.