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Legal Developments of China’s Micro-credit Industry

October 2012 - Finance. Legal Developments by Jingtian & Gongcheng.

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Micro-credit companies, which provide lending services for farmers, individual industrial and commercial households, and small and medium-sized enterprises, have become an important channel for private capital to enter the financial market and a significant supplementary power of China's credit market.

Micro-credit companies, which provide lending services for farmers, individual industrial and commercial households, and small and medium-sized enterprises, have become an important channel for private capital to enter the financial market and a significant supplementary power of China's credit market.

China has experienced explosive growth in micro-credit companies in recent years. According to the 2011 Statistical Report of Micro-credit Companies issued by the People's Bank of China ("PBOC"), as of the end of December 2011, there were 4,282 micro-credit companies in China, which was more than 8 times the number in 2008. In 2011, micro-credit companies employed 47,088 people nationwide, with a total loan balance of 391.5 billion yuan (62.05 billion U.S. dollars), said in the report.

Since the micro-credit industry is in its infancy in China, it still faces strict scrutiny from regulatory authorities. The major regulations on micro-credit companies applicable throughout the country are the Notice of the People's Bank of China and the China Banking Regulatory Commission on the Relevant Policies for Village and Town Banks, Loan Companies, Rural Mutual Cooperatives and Micro-credit Companies (中国人民银行、中国银行业监督管理委员会关于村镇银行、贷款公司、农村资金互助社、小额贷款公司有关政策的通知), promulgated and effective on April 24, 2008 and the Guiding Opinions of the China Banking Regulatory Commission and the People's Bank of China on the Pilot Operation of Micro-credit Companies (中国银行业监督管理委员会、中国人民银行关于小额贷款公司试点的指导意见) ("Guiding Opinions"), promulgated and effective on May 4, 2008. In addition, many local regulations on micro-credit companies have been enacted based on the specific circumstances and actual needs of the locality.

This essay describes the legal developments of micro-credit industry by comparing the regulations applicable nationwide and the regulations issued by local governments. We chose the regulations of Inner Mongolia Autonomous Region, Shandong Province, Zhejiang Province, Tianjin and Shenzhen as examples to illustrate the developments of regulations of micro-credit companies in different regions of China.

INVESTORS

The Guiding Opinions generally states that the natural persons, corporate legal persons and other social organizations who or which have invested in and incorporated a micro-credit company shall have no criminal record or bad credit history.

More detailed regulations on investors of micro-credit companies were set out by local governments based on their locality. The Implementing Rules of Inner Mongolia Autonomous Region for Administrating the Pilot Operation of Micro-credit Companies (内蒙古自治区小额贷款公司试点管理实施细则), which is promulgated by the Finance Office of Inner Mongolia Autonomous Region and became effective on July 16, 2008, provides that the investors of a micro-credit company may include domestic natural persons, domestic legal persons, other domestic social organizations, foreign institutions, and other investors recognized by the Inner Mongolia Autonomous Region Finance Office. As for a foreign investor, it must be a micro-credit organization or financial institution.

Shandong Province adheres to the principle of localization, requiring that the proportion of local shareholding shall not be less than 60%. The newly adopted Opinions on Advancing the Normative and Healthy Development of Micro-credit Companies (关于促进小额贷款公司规范健康发展的意见) ("Opinions of Shandong Province on Micro-credit Companies"), which was promulgated by the General Office of the People's Government of Shandong Province and became effective on April 6, 2012, relaxes the aforementioned corporate shareholders regional and ownership restrictions by providing that, upon approval in accordance with law, foreign investors, enterprises with outstanding investment conditions incorporated in other provinces are allowed to establish micro-credit companies in Shandong Province.

RESOURCES OF FUND

The main resources of fund of a micro-credit company, as provided in the Guiding Opinion, comprise capital paid by shareholders, donated funds and loans granted by banking financial institutions of no more than two as long as the aggregate amount of which does not exceed 50% of registered capital of the micro-credit company. In addition, absorbing public deposits or borrowing funds from individuals or enterprises other than banking financial institutions is not allowed.

The Interim Measures of Zhejiang Province for Supervision and Administration of Micro-credit Companies (浙江省小额贷款公司日常监管暂行办法) ("Interim Measures of Zhejiang Province"), which is the first financing regulatory measures of micro-credit company in China, allows directional borrowing of micro-credit companies from their shareholders. Under the Interim Measures of Zhejiang Province, a micro-credit company may borrow from corporate shareholders who own more than 5% of its shares, as long as the amount borrowed does not exceed the upper financing ratio provided by the Interim Measures or exceed the interests the shareholders holds as business owner at the time of such borrowing. The Interim Measures of Zhejiang Province further provides that a micro-credit company may transfer or borrow funds from other micro-credit companies of the same city and carry out asset transference business by means of repurchase by cooperating with banking financial institutions, local financial assets trading platform and other parties.

Directional borrowing of micro-credit companies from their shareholders is also allowed in the financial innovation pilot counties of Shandong Province. According to the Opinions of Shandong Province on Micro-credit Companies, directional borrowing of micro-credit companies from corporate shareholders is allowed as long as the shareholding ratio of such shareholder reaches 15% and the amount borrowed from does not exceed 2 times the amount of registered capital such shareholder has contributed to the company. Moreover, a micro-credit company incorporated in the financial innovation pilot counties of Shandong Province may transfer or borrow funds from micro-credit companies of the same county and carry out cooperation with banking financial institutions and financing guarantee companies.

OPERATING REGIONS

Under the Guiding Opinions, China's local governments are authorized to launch their own pilot operation of small-sum loan companies only within prefectural regions of their respective province (district, city).

Followed by the aforementioned restrictions, cross-regional business of micro-credit companies is prohibited in Shandong Province. According to Tentative Measures of Shandong Province for Registration Management of Micro-credit Company (山东省小额贷款公司登记管理试行办法) promulgated by the Industrial and Commercial Bureau of Shandong Province and effective on September 10, 2008, a micro-credit company shall carry out its business within the operating regions approved by the approving authority and its scope of business shall indicate "to carry out business within the provisions of national laws and regulations".

Similar to the provisions in Shandong Province, Tianjin Interim Measures for Administration of Micro-credit Companies (天津市小额贷款公司管理暂行办法) ("Tianjin Administration Measures") explicitly stipulates that a micro-credit company incorporated in Tianjin shall not carry out business outside the region of Tianjin.

BORROWERS

The Guiding Opinions provides that micro-credit companies shall have the freedom to choose their prospective borrowers under the principle of serving the farmers, agriculture and rural economy. The loan balances of a borrower shall not exceed 5% of net capital of the micro-credit company. The Guiding Opinions further provides that, within the above criteria, local governments are allowed to set their respective limit for maximum loan amount by referring to local economic conditions and per-capita GDP.

Micro-credit companies in Shenzhen are encouraged to provide credit services for small and medium-sized enterprises, individual industrial and commercial households, and individual entrepreneurs. Under the Shenzhen Interim Measures for Administrating the Pilot Operation of Micro-credit Companies (深圳市小额贷款公司试点管理暂行办法), the loan balances of a borrower shall not exceed 5% of net capital of the micro-credit company or exceed 5 million yuan (0.79 million U.S. dollars).

Tianjin Interim Measures on the Pilot Operation of Micro-credit Companies (天津市小额贷款公司试点暂行管理办法) requires that 70% of funds of a micro-credit company shall be lent to the borrowers whose respective loan balances do not exceed half a (0.5) million yuan (79.5 thousand U.S. dollars), and as to the rest of funds, the loan balance to the same borrower shall not exceed 5% of net capital of the micro-credit company. However, under the newly adopted Tianjin Administration Measures, such provision is allowed to lapse.

INTEREST RATES FOR LOANS

Guiding Opinions provides that the lower limit for loan rate of a micro-credit company is 90% of the benchmark rate for loans published by PBOC and the upper limit is the same upper limit as required by judicial authority, namely 400% of the benchmark rate for published by PBOC. So far there is no special rule of loan rate of micro-credit company issued by local governments.

SUPERVISION AND ADMINISTRATION

According to the Guiding Opinions, a provincial government may launch the pilot operation of micro-credit companies only after a competent department, e.g. Finance Office, is designated to be responsible to supervise and administrate micro-credit companies. The Guiding Opinions also requires that micro-credit companies shall establish a prudent and normative asset classification and allocation system, an initiator promise system, an information disclosure system, and sound corporate governance structures in accordance with the principals set by PRC Company Law.

Apart from the aforementioned supervisory and administrative measures applicable throughout the nation, Shandong Province set out more detailed supervision rules for local micro-credit companies. The Interim Measures of Shandong Province for Supervision and Administration of Micro-credit Companies (山东省小额贷款公司监督管理暂行办法) ("Shandong Interim Measures"), which is promulgated by the General Office of the People's Government of Shandong Province and became effective on September 7, 2009, provides, among other things, that the Shandong Province Finance Office is the provincial administrative department in charge of risk prevention and disposal of micro-credit companies and the municipal finance offices take the responsibilities of auditing the pilot scheme from county government and supervise the operation of micro-credit companies within the city. The Shandong Interim Measures also provides that a micro-credit company shall choose a Chinese-funded banking financial institution as its chief bank and county departments in charge shall appoint one official staff as the principal supervisor for each micro-credit company incorporated in that county. Furthermore, classification rating criteria of micro-credit companies was introduced by Measures for Classification Rating of Micro-credit Companies in Shandong Province (Trail) (山东省小额贷款公司分类评级办法(试行)), in which micro-credit companies are divided into five grades based on certain rating criteria.

DEVELOPMENT TREND

Financial innovation is emphasized in China nowadays. On March 28, 2012, the State Council declared its reform program to establish a finance comprehensive reform pilot area in the eastern city of Wenzhou to regulate private financing activities. The reform program, among other things, encourages private capital to participate in the reform of local financial institutions and specifies that eligible micro-credit companies could be transformed into village and town banks.

The reform program is a good signal for the development of micro-credit companies in China but it is still too early to judge the real effects without specific supporting rules.


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