C&B Notes

The Wild, Wild East

While China is far from the only country that suffers from corruption, the scope of a recent case, the lack of controls that enabled it, and the banking structure that birthed it caught our eye.

Fraudulent loans are on the rise in China as economic growth slows, threatening to further undermine the country’s $29tn banking system, which is already under pressure from an indebted corporate sector.  A series of loan frauds has ripped holes in the balance sheets of a range of lenders, from the large — Agricultural Bank of China — through to the phalanx of small commercial lenders.

The latest victim to emerge is Bank of Liuzhou where $4.9bn (Rmb32.8bn) in fraudulent loans were discovered by the bank late last year, according to the state-backed China Business Journal.  That represents more than 40 per cent of the bank’s total assets of Rmb80bn at the end of 2014 — a dent so large on the bank’s balance sheet that it is likely to require government intervention.  “I guess local government may have to swap the bad loans with asset injections to address the solvency issue,” said Liao Qiang, director of financial institutions ratings at Standard & Poor’s in Beijing.

Fraud, which often takes the form of forging collateral, is also a result of corruption, where local government enterprises bribe small banks to grant them huge loans.  Cases such as these have left banks and investors nursing big losses.  Poor internal controls make the fraud harder to catch early.  In the case of Liuzhou, a new chairman at the bank in 2014 discovered the massive pile of debt accrued by one borrower during the tenure of the previous bank head.  Upon that revelation, the borrower, a businessman, allegedly ordered the murder of the chairman, China Business Journal reported.

An investigation by the bank reportedly showed that the businessman and certain relatives had forged collateral and proof of business operations to borrow $4.9bn.  Local media in China said that up to Rmb7.9bn — more than eight times the bank’s 2014 profits — in fraudulent loans was expected to be unrecoverable.