Risks and precautions for nominee loans

China’s existing laws and administrative regulations do not yet offer a specific definition of nominee loans. In this article, the term refers to loans obtained by actual users with the consent of nominee borrowers, using the nominees’ information to obtain a loan from a financial institution.

As nominee borrowers are not the actual users, such loans pose compliance risks to financial institutions. These loans also hinder institutions’ ability to accurately identify and assess the risk level of the actual borrowers, making it harder to subsequently collect loans.

Financial institutions are advised to pay due attention to nominee loans.

The risks

Prudent operations

The rules of prudent operations aim to prevent and control risks in financial institutions. They require the institutions to identify, measure, monitor and control various risks.

Drawing on the Core Principles for Effective Banking Supervision by the Basel Committee regarding prudent operations in the banking sector, China’s Banking Supervision Law clarifies, in article 21, that rules on prudent operations include, but are not limited to, risk management, internal control, capital adequacy ratio, asset quality, loss reserve fund, risk concentration, related-party transactions and assets liquidity. Nominee loans violate the rules on prudent operations, which should be penalised by regulators according to article 46 of the Banking Supervision Law.

For example, in October 2023, the Jinhua office of the National Administration of Financial Regulation issued an administrative penalty after finding breaches of the banking law. The office determined there had been inadequate pre-lending investigation, examination at the time of granting loans, and post-lending inspection (three inspections) before an agency granted nominee loans. It imposed a fine of about USD41,000, as per article 21 and article 46 of the Banking Supervision Law and relevant rules on prudent operations.

Suspicion of crime

According to China’s Criminal Law, personnel of financial institutions who grant loans by violating the Law on Commercial Banks and other laws and regulations, and if the sum is huge or serious loss has resulted, may have committed the crime of illegally granting loans.

Collection difficulties

Firstly, nominee loans will hinder financial institutions from accurately identifying and assessing the risk of the actual borrowers. The actual borrowers are usually ineligible for loans and their repayment ability is not guaranteed.

Secondly, nominee loans involve three parties and are more likely to result in disputes. Any dispute between a financial institution and a nominee borrower or an actual user, or between the nominal borrower and the actual user, will impose higher risks on loan collection and bring potential economic losses to the institution.

Furthermore, higher non-performing asset ratios will lead to lower profits, higher costs and lower risk tolerance for financial institutions, exposing them to regulatory pressure.

The countermeasures

Regulations

Financial institutions should faithfully implement rules on prudent operations according to the Banking Supervision Law and sign loan contracts with actual users. In addition, pay attention to other regulations in the financial industry and learn from them as necessary.

For example, the General Office of China Banking Regulatory Commission issued the Notice on Risk Warning for Granting Loans by Impersonation by Small and Medium-sized Rural Financial Institutions on 15 June 2009, which provides regulatory recommendations on impersonation loans.

Although intended for small and medium-sized rural financial institutions, the notice provides for strict credit granting, loan procedures standardisation and the method of “three inspections”, serving as a reference for financial institutions in avoiding nominee loans.

Litigation

Although nominee loans do not meet financial regulations, they do not necessarily violate valid and mandatory provisions of laws and regulations. The entrusted loan relationship between nominee borrowers and actual users and loan contracts, signed between nominee borrowers and financial institutions, are not necessarily invalid. Therefore, recovering loans through litigation is also feasible.

In practice, different courts handle the relationship between nominee borrowers and actual users variously. Published in the first issue of the Journal of Law Application in 2023, On the Concepts, Mechanisms and Legal Application Issues for the Trial of Financial Civil and Commercial Cases embodies the spirit of the National Court Financial Work Conference held on 10 January 2023.

It states that nominee loans should apply to the agency system, reflecting the tendency of courts in similar cases, and providing guidance to both financial institutions and courts in decision-making.

In this view, if a financial institution signs a loan contract with knowledge of the agency relationship between the actual users and the nominee borrower, the loan contract directly binds the commercial bank and the actual borrower; if the institution has no clue of the relationship when the nominee borrower discloses the actual users, it has an irreversible right to choose either the nominee borrower or the actual user as the counterparty.

Financial institutions should consider the difficulty of loan collection and the actual circumstances to determine who should be the ultimate re-payer.

Guang Zhenming is a senior partner at Joint-Win Partners