Factoring Draws Attention of China’s Bank Regulator

September 3, 2013, 6:43 a.m. ET

Factoring Draws Attention of Bank Regulator

Regulator Seeks Better Monitoring of Innovative Lending

BEIJING—China’s banking regulator has instructed banks to better monitor a type of lending particularly popular with small firms as demand burgeons and banks relax their oversight standards. According to a document from the China Banking Regulatory Commission seen by The Wall Street Journal, loans made against companies’ accounts receivable—those sales for which a company has yet to receive payment—must be recorded as nonperforming loans if they turn bad. Banks also need to be sure that such loans are in fact backed by receivables.China’s financial system has developed quickly in recent years as banks have raced into new business areas in anticipation of interest-rate liberalization, a promised goal of the central government that is expected to make their traditional business of lending and taking deposits less profitable.

But the flurry of financial innovation, while in many cases useful to the broader economy, is creating risks that the banking regulator is struggling to keep up with. On Monday, CBRC Chairman Shang Fulin warned that “the scope…of financial risk is changing and the complexity is rising.”

China’s slowing economy has resulted in a significant increase in accounts receivable as buyers struggle to pay their bills on time and sellers relax their marketing terms to encourage sales. By selling their receivables to banks—a process known as factoring—a company can get the cash it needs up front rather than having to wait for customers to make good on a payment. The bank turns a profit by buying the receivables at less than what it will eventually collect as payment.

It is a particularly useful tool for small firms, which often struggle to tap bank funding, though some of China’s biggest industries, such as construction-machinery makers, also use it.

The document is dated July 31 and was distributed to banks last month but wasn’t made available to the general public. It warned that in some cases, companies were faking records of receivables as a way to access bank credit and that banks “had relaxed their checks on [companies’] finances.”

A banker in the international settlement department of a major state-owned bank, who declined to be further identified, said that defaults on accounts receivable bought by his bank had been rising.

There is relatively little data on how much factoring business the banks currently do, although the statement said it had expanded “particularly quickly.”

Individual banks have disclosed some information on the business, however.

Shanghai Pudong Development Bank Co. 600000.SH +1.34% has said that it did 130 billion yuan ($21 billion) worth of factoring business in the first half of the year, up 51% from the same period last year. That is equivalent to about 8% of the new loans it made between January and June.

China Merchants Bank Co. 600036.SH -0.37% said it earned 562 million yuan in income from its factoring business in the first half, an increase of almost 150% over a year earlier.

Bank of Communications Co. 601328.SH +1.52% and Agricultural Bank of China Ltd.601288.SH +1.22% both said in their half-year earnings reports that their factoring business expanded rapidly.