In a contract for international sales of goods, the seller and buyer may agree on using the US dollar as settlement currency. When a payment dispute arises in connection with contract performance, usually the claimant claims arrears and loss of interest against the respondent. The outstanding principal amount can be claimed in the agreed currency, such as US dollars. As for the overdue interest, according to relevant stipulations it needs to be calculated based on the RMB benchmark lending rate for the same term, as published by the People’s Bank of China (PBOC), if there is no mutual agreement on how overdue interest should be calculated. However, does the RMB benchmark lending rate apply if the principal is denominated in US dollars or any other foreign currency?
Having reviewed dozens of PRC judicial cases, the authors found that about 60% are of the opinion that the PBOC’s US dollar lending rate for the same term must apply to calculation of interest loss on occasions where the outstanding arrears are US dollar-denominated. So then, how is this US dollar lending rate determined?
Regulations of the PBOC concerning US dollar lending rate. According to the General Provisions on Loans, interest must accrue on loans periodically according to the PBOC’s regulations concerning accrual of interest. Moreover, with approval from the State Council, the PBOC has announced that, since 21 September 2000, the interest rate, accrual and settlement of interest on foreign currency loans must be determined by financial institutions in line with the prevailing interest rates of international financial markets, as well as their own capital costs, risk differences and other appropriate factors. That is to say, the PBOC has given financial institutions the discretion to fix the interest rate for their US dollar loans. The authors have consulted the PBOC’s headquarters in Shanghai about this issue and learned that the interest rate of specific US dollar loans is indeed fixed by commercial lenders at their discretion.
Rules of financial institutions concerning US dollar lending rate. In practice, determining the interest rate of a US dollar loan is not simple for three reasons. First, now that the PBOC has empowered financial institutions to fix the interest rate of foreign currency loans on their own, it will not announce a US dollar lending rate on any public occasion. Second, financial institutions do not publish a US dollar lending rate, given that they fix interest rates for foreign currency loans on a case-by-case basis. Third, since the interest rate for each loan depends particularly on the purpose, amount and maturity of the loan, the authors have no idea about the interest rate of a loan unless we consult the lender.
Therefore, if the parties to a transaction want to know the US dollar lending rate that financial institutions are likely to provide, they may, first of all, determine how and for what purpose the foreign currency loan is used, or they may fit their transaction into a typical scenario. As a second step, they can try to identify the category of US dollar loans that is similar with, or close to, the nature of the one they are seeking, and find out the interest rate of this category.
For example, one category of US dollar loans in China provides funding for export of goods, for which there is a relatively stable method for fixing interest rates or accruing interest. When an export transaction needs US dollar funding, the parties concerned may ask financial institutions about their lending rate for this category. Based on the information about the interest rates of US dollar loans for export of goods that we learn from several Chinese banks providing US dollar-denominated facilities, the interest rate of this category of US dollar loans is calculated according to the following formula:
Interest rate of a US dollar commercial loan for export of goods = LIBOR/HIBOR (London interbank offered rate/Hong Kong interbank offered rate) + floating spread (2%-5%). An interest rate fixed in this way is approximately 30% above the PBOC’s RMB lending rate for the same term.
The table on this page outlines the interest rates of some US dollar loans based on sources from the PBOC (these rates are substantially the same as LIBOR rates, although lenders generally fix commercial lending rates at levels that are 2%-5% above the rates in the table in view of the higher risk exposure of commercial lending than interbank lending).
How to choose a benchmark rate for US dollar loans when calculating interest. Option 1: the parties may agree to using the US dollar lending rate of a certain financial institution as the benchmark rate. This option benefits from a precise flat rate, but background information of the transaction needs to be provided to the bank before interest calculation so that it can assess the level of the US dollar lending rate to be applied.
Option 2: the parties may agree on a rate with certain floating spread (e.g. 2%-5%) above LIBOR or about 30% above the PBOC’s RMB lending rate. Interest can be readily calculated with this option. However, without assessment by a financial institution, it is likely that the mutually fixed floating spread deviates from fair market prices. This may have a significant impact on rights and obligations of the parties when the principal amount is substantial.
In practice there are judges who, possibly with consideration to circumstances specific to their cases, order calculation of overdue interest on foreign currency arrears with the PBOC’s US dollar deposit rate for the same term, LIBOR rate for the same term, or the PBOC’s lending rate for loans of the same term denominated in RMB or in any foreign currency other than the ones of the arrears. It should be noted that the prevailing party may find it difficult to enforce the rulings if the interest calculation method determined cannot be verified or does not exist in practice. Further study may be needed on this issue.