Opinion: Shenzhen Passes Milestone With Personal Bankruptcy Regulation
Cai Kailong is a senior research fellow with the Fintech Institute of the Renmin University of China.
Shenzhen recently released a draft personal bankruptcy regulation for public comment, a major milestone for personal bankruptcy legislation, which has been under discussion in China for over a decade.
For individuals, those who are honest but unfortunate will be able to avoid unlimited transfer of corporate debt to themselves or their families. However, the personal bankruptcy system should never protect those who maliciously repudiate debts.
For financial institutions, the regulation may push up operation costs and increase the risk of bad debts, but as long as they strengthen risk controls and product design and only lend money to those deemed appropriate, the rules can maximize the use of social resources.
For society as a whole, the personal bankruptcy system needs to break implicit guarantees to better maintain a level playing field for individuals and financial institutions, and facilitate prevention of financial risks and the establishment of a social credit system.
People can file for personal bankruptcy when their overdue debts exceed their assets, allowing the court to declare the person bankrupt and liquidate and distribute the person’s property, or alternatively, to restructure the debts, and further determine the bankrupt person’s rights and obligations.
When financial institutions lend to companies, they generally require the companies’ legal representatives, senior managers or even their family members to sign guarantee agreements. According to current Chinese law, once a company goes bankrupt, those guarantors are not exempt from the debt. While companies often have an opportunity to make a comeback, individuals do not.
Shenzhen is the first city in China to try to introduce a personal bankruptcy system. The draft rules stipulate that creditors who individually or jointly hold maturing claims of more than 500,000 yuan ($70,750) to a debtor can apply for bankruptcy liquidation for the debtor. Also, the draft rules make it clear that debtors are not allowed to serve as directors, supervisors or senior managers of listed companies, unlisted public companies or financial institutions.
Shenzhen legislators have said that setting up a personal bankruptcy system can effectively clarify the risk-bearing duties of market entities and urge financial institutions to improve their credit evaluation and risk control systems. It can also guide companies and the public to better their understanding of credit, helping promote the creation of a social credit system.
The core of personal bankruptcy is debt relief. In a sense, the personal bankruptcy system provides honest but unlucky debtors with a predictable and reliable guarantee.
Therefore, the basic value of personal bankruptcy legislation should center on the notion that only honest and trustworthy debtors can receive bankruptcy protection when they fall into debt distress, and that the system can help them get out of the hole to participate again in social and economic activities.
Of course, when the personal bankruptcy system is in place, those with records of bankruptcy may experience some restrictions. Their loan applications might be refused and their credit lines could shrink.
Protection for financial institutions
There is no doubt that companies involved in personal lending will be affected once a personal bankruptcy system is in place. In essence, personal bankruptcy will replace unlimited debt liabilities with conciliation, liquidation or debt restructuring, which would reduce the final payback amount of a loan. That would also directly increase the proportion of bad debts for financial institutions.
Rising bad-debt costs will challenge financial institutions’ risk control. If they are not able to respond, their profits would shrink, resulting in increasing lending rates and finally loss of clients.
Personal bankruptcy legislation can also be seen as striking a balance between the interests of individual borrowers and lending institutions. One can see it as breaking an implicit guarantee.
Financial institutions often implicitly guarantee that they will repay principal and interest of financial products regardless of the level of risk. This is a bad mindset that goes against the market economy. Financial institutions requiring borrowers to make payments can also be seen as an implicit guarantee.
Since individual investors should not require financial institutions to guarantee returns, there is no reason why financial institutions should demand unlimited liability from borrowers. Over-protection of either side will lead to an imbalanced lending market.
The introduction of personal bankruptcy legislation is an important step towards a market economy. But there is a long way to go, and steady progress will require careful planning.
This commentary has been edited for length and clarity.
Contact translator Timmy Shen (email@example.com) and editor Gavin Cross (firstname.lastname@example.org)
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