Tuesday, June 27, 2006
China Reveals $1.1B Bank Fraud
Corruption Threatens Foreign Investment
By Peter S. Goodman
Washington Post Foreign Service
Tuesday, June 27, 2006; 11:10 AM
SHANGHAI, June 27 -- The Chinese government's disclosure this week of $1.1 billion worth of fraud at one of the country's largest state-owned banks underscores the risks confronting foreign investors and the precarious nature of China's corruption-ridden financial system.
China's National Audit Office on Monday announced that an examination of records at the Agricultural Bank of China -- one of four state-owned giants -- uncovered 51 cases of criminal wrongdoing involving 157 people during 2004. The state audit also found evidence of $1.8 billion in improperly handled deposits, and $3.5 billion in illegal loans.
The latest details of fraud come as China presses to eradicate the taint of corruption from its state-owned banks as it courts foreign capital in a bid to improve management practices. China's leaders are particularly keen to fix its ailing lenders ahead of next year, when foreign banks will finally be allowed to conduct business inside China in local currency. That is expected to pose a grave challenge to domestic lenders, whose managers have been nurtured by decades of state capital infusions and a system governed more by personal connections than consideration of the bottom line.
The most recent additions to a lengthy roster of bank-fraud cases brings to the fore a basic question about the future of China's financial system: Are the state disclosures a sign that the government is indeed serious about fixing the troubles, or just another indication of the extent of the problems in a fundamentally shaky system? Analysts saw a little bit of both. While the state is indeed intent on a fix, the challenges are deep.
"This case that has emerged at the Agricultural Bank of China is just a minor one among the overall problems with China's state owned banks," said Yi Xianrong, a director at the China Academy of Social Sciences' financial research institute in Beijing. "Lots more such cases are not discovered and will be discovered sooner or later, as the most serious problems involve medium- and long-term loans."
He cited deep institutional problems at the banks, including a lack of internal controls. "More fundamentally, the system appoints bank leaders based on administrative power rather than on market performance," Yi said. "Real changes have yet to come."
For foreign investors, the stakes tied to reform are high. Last year, Bank of America paid $3 billion for a 10 percent stake in the Bank of China, with the Royal Bank of Scotland taking another 10 percent of that lender. This month, Bank of China raised some $9.7 billion through a stock offering of stock in Hong Kong, following a $9.2 billion stock offering there by China Construction Bank.
Last August, Goldman Sachs Group Inc. sank $3 billion into China's largest lender, the Industrial & Commercial Bank of China, capturing a 10 percent stake. The bank has said it will pursue a stock offering worth some $12 billion in Hong Kong sometime this fall.
Foreign investors are eager to lock up stakes of banks in China's huge, sizzling economy. With stock and bond markets still in their infancy, China's four largest state banks essentially dictate where capital goes in China. But the foreigners are sinking their money into a financial system that has traditionally functioned more as an artery of cash for companies owned by the Communist Party-led government then as careful arbiters of risk and reward.
Private economists estimate that China's banks are now choked with $500 billion in bad loans, making the system vulnerable to a shock. Those worries have heightened in recent weeks with the release of government data showing a surge in lending during the first five months of the year, despite government caps on investment in red-hot sectors such as real estate and automobile manufacturing.
On Tuesday, the debt rating agency Standard & Poor's underscored those concerns, declaring that China's banks face "increasing vulnerability" from the widening volume of lending. The agency credited China's banks with some improvements in their governance, but stressed that "their developing credit and risk management systems are likely to be severely stretched by rapidly changing economic conditions."
The Agricultural Bank has long been seen as the most flawed of the four state-owned giants. Four years ago, bank officials announced plans to embrace consumer finance as a way of weaning itself off more politically motivated lending. The bank moved aggressively into the fledgling business of auto finance, seeking to profit as China's growing middle class embraces the family car.
In interviews, bank officials then acknowledged that credit checking systems were virtually non-existent in China. They said that so long as would-be borrowers accurately disclosed their addresses and incomes, few applicants would be turned away.
This week's disclosures added to the evidence that the resulting consumer finance frenzy has turned sour: The state auditors said that among the biggest areas of fraud in the cases it discovered were car loans and home mortgages.
"The banks have been desperately expanding loans including consumer loans and real-estate loans," Yi said. "The problem won't be visible until real estate prices fall dramatically, which will happen sooner or later. The problem with individual consumer loans is serious."