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.
- In an entrusted loan arrangement, the loan is organized between the borrower and the lender by an agent bank.
- The agent bank takes on the duties of trustee—responsible for collecting the loan principal and interest—but does not take on any of the loan risks.
- Entrusted loans are common in China, where they offer companies with idle cash the opportunity to earn interest income by allowing the agent bank to loan out the funds.
- In 2018, Chinese officials clamped down on entrusted loans after recognizing risks caused by the loans' lack of transparency and regulation.
- Entrusted loans must now meet requirements aimed at strengthening supervision and risk management, increasing disclosures, and controlling leverage.
How Entrusted Loans 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 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 risks.
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 overleveraged, as well as whether the quality of companies obtaining credit through these arrangements was holding steady or declining.
Requirements for Entrusted Loans
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. While the Chinese government acknowledged that the entrusted loan business had grown fast and had played a positive role in the economy, the lack of regulations meant there were hidden risks. These risks compelled Chinese regulators to implement measures to control leverage, along with putting greater scrutiny on shadow banking and lending practices.
The rules, issued by the China Banking and Insurance Regulatory Commission (CBIRC), 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.
Under the tightened rules, the CBIRC strengthened the supervision and risk management required for entrusted loans. Additionally, commercial banks are required to issue disclosures on the source and intended use of the funds. The rules prohibit the use of funds for investment in government-banned sectors. In order to control risk, banks must also create strict separations between their own business activities and their entrusted loan business.
Example of Entrusted Loan
With an estimated market capitalization of approximately $242.3 billion, the Industrial & Commercial Bank of China (ICBC) is one of the four biggest banks in China. The ICBC's corporate banking segment offers trade financing, corporate loans, and various intermediary services to government agencies, large corporations, and other financial institutions.
One of the intermediary services the ICBC offers is to act as an agent of entrusted funds in the entrusted loan process. As a trustee, the ICBC does not advance the loan principal or interest, nor does it recommend the borrower or guarantor. According to its website, It does not offer guarantees for the loan and it does not, directly or indirectly, take any loan risk in any form.
However, the bank does provide several financial intermediary services, such as:
- Monitoring the use of the loan
- Monitoring the performance of the borrowers and guarantees
- Collection of loan repayment and interest on behalf of the principal
- Assistance in the safekeeping of the mortgage, pledge, and title documents