Addressing non-performing personal loans

China’s expanding consumer credit market has brought mortgages and personal lending into the financial mainstream. Yet, pressured by shifting market conditions, volatile borrower repayment capacity and institutional management weaknesses, non-performing personal loans continue to climb. Meanwhile, tighter financial regulation has led to a surge in sanctions and litigation triggered by procedural non-compliance and risk control gaps.

Scope

Under the Measures for the Administration of Personal Loans, effective since 2024, overdue personal credit forms four categories of non-performing loans: home mortgages; vehicle loans; consumer credit; and business loans.

Amid rising bad debts and tighter financial supervision, financial institutions risking non-compliance face penalties, executive accountability and reputational damage, making strict compliance essential.

Risk control

Controlling risk at the lending and post-lending stages allows lenders to reduce non-performing loans at the source and ease recovery pressures downstream. Common lending pitfalls include lax underwriting, undetected fraud, unmonitored fund usage, flawed collateral procedures, loose contract terms and poor record-keeping.

Under the Measures for the Administration of Personal Loans, lenders must implement end-to-end management, carrying out information checks, standardising collateral registration, and improving contract and archive management to secure the lending compliance baseline.

It also means enhancing post-lending visits and risk reviews, standardising default notices, leveraging smart early warning systems and adjusting repayment terms or obtaining extra security to mitigate emerging risks.

Remedies

When a loan is non-performing, three main remedies are collection, litigation and non-litigation, each subject to legal constraints.

Collection. Debt collection operates within a strict legal framework. Personal rights are afforded priority protection, and financial institutions must not harm borrowers’ legitimate interests when seeking repayment.

Contact-list exposure is a typical breach. Unauthorised disclosure of debt and personal information contravenes the Personal Information Protection Law and infringes privacy and personal information rights.

It also violates the Public Security Administration Punishments Law, with individuals liable to detention or fines and financial institutions exposed to regulatory action.

Borrowers may seek civil damages under the Civil Code, and regulators may impose heavy penalties for serious breaches.

A compliant collection process should first seek to reach the borrower directly and always maintain professional communication. Third-party collection agencies should be carefully vetted, with compliance obligations clearly set out in the service agreement.

Emergency contacts may only be approached when the borrower cannot be reached, and no debt information may be disclosed. The entire collection process should be recorded and archived.

Litigation. When collection efforts stall, litigation becomes essential for protecting creditors’ rights. Yet proceedings can be hampered by weak evidence, expired limitation periods and slow asset recovery.

To address these, financial institutions must build robust evidence chains, monitor limitation and guarantee periods to interrupt statutory timers via compliant collection, and leverage pre-enforcement notarisation where eligible. Following a favourable verdict, lenders must request asset freezes and apply sanctions to dishonest debtors, pushing execution forward to recover debts.

Non-litigation. Non-litigation tools such as repayment negotiations, debt restructuring and commercial arbitration are now widely used by financial institutions to resolve non-performing personal loans. Yet these solutions involve discretion and varied operational settings, making them subject to strict regulatory oversight.

Weaknesses in contract drafting, counterparty selection or process management can lead to void agreements, regulatory sanctions or unrecovered claims. These compliance vulnerabilities remain the most critical flashpoints for frontline business operations.

Contractual compliance risk poses the first major challenge. Where financial institutions rely solely on informal oral or messaging-based agreements to modify repayment terms, the resulting arrangements lack enforceability, severely compromising debt recovery options.

For example, an urban commercial lender negotiated a fee-waived instalment plan over WeChat without executing a formal variation agreement. Following subsequent borrower default, the messaging records failed to serve as a valid contract, compelling the bank to enforce the original agreement – which extended the resolution timeline and rendered a negotiated compromise defunct.

Debt workouts and loan modifications must therefore be executed through formal written contracts specifying detailed terms.

Secondary to this is counterparty eligibility risk. Financial institutions must thoroughly vet potential partners, deal strictly with licensed entities, and embed clear compliance requirements and legal recourse in their contracts. Outsourcing to unlicenced firms automatically voids the agreement and invites regulatory penalties.

In a recent case, a county-level rural commercial bank contracted its recovery and payment collection operations to an unlicensed commercial firm. Regulators stepped in, annulled the deal, fined the lender, ordered remedial action, and held the managing officers personally accountable. Procedural compliance risk represents another critical vulnerability. Failing to maintain comprehensive records and archives across negotiations, contract execution and policy modifications breaks the chain of evidence, leaving financial institutions at a disadvantage in legal disputes.

For instance, a bank modified a repayment schedule over the phone without keeping audio recordings or written documentation. Following a subsequent default, conflicting accounts delayed court proceedings and severely disrupted recovery efficiency.

Lenders must therefore enforce end-to-end evidentiary trails and mandate written documentation for all contract amendments.

The final threat is regulatory arbitrage. Some lenders attempt to dodge regulatory constraints and flatter short-term, bad-debt metrics by splitting debt portfolios or embedding hidden repurchase obligations to hit performance targets.

Such practices breach regulatory red lines. Once detected, the underlying transactions will be unwound, and institutions face fines and supervisory rating downgrades that impact core business operations.

Chen Yanhong is a senior equity partner at DHH Law Firm and an associate professor at North China Electric Power University (Beijing)