SINGAPORE, March 30 (UPI) -- Risk management in the Chinese banking sector has long been an issue, but the authorities are finally tightening the screw with a raft of measures designed to steam off corruption and improve internal controls in the sector.
In recent weeks, the banking sector has been hit by a spate of corruption scandals touching all the echelons of management. From the Chairman of China Construction Bank who recently resigned because of suspected corruption (A U.S. lawsuit alleges he received $1 million from a unit of Fidelity National Financial Inc in the U.S. to fabricate orders to supply the bank with financial software) to the lone typist at the Bank of China's Dalian branch embezzling over the years $6 million to feed his gambling habit, the level of corruption has taken such proportion that the authorities are worried it will dampen foreign investors' interest when the banks start to be privatized later this year.
The China Banking Regulatory Commission (CBRC) recently revealed it had uncovered 98 cases of fraud at three branches of Agricultural Bank of China, the smallest of the Big Four state lenders, in Inner-Mongolia over a 12-month period starting mid-2003, which resulted in a loss of $14 million for the banks.
"The emphasis on our work from now on is to resolve the system of internal management and supervision," noted Tang Shuangning, vice-chairman of the regulator.
Now the authorities have announced plans to make senior managers legally responsible for major fraud cases, while it will be offering bank employees generous rewards to expose corrupt activities to regulators.
"I think you can expect the government will continue to introduce more supervision rules in order to bring these (banks) in line international practice," said Peter So, head of China research at Macquarie Securities, adding this was especially important given that some of them are gearing to list.
Beyond the issue of corruption, the authorities also want banks to improve their management of loan risk and derivative activities. Banks already granted licenses to trade derivatives will start self-inspection and submit their inspection reports to the banking regulator, while any bank trading in derivatives without a license will be punished, with the officials involved facing legal proceedings.
Banks must "draw a lesson" from the huge trading losses incurred by jet fuel importer China Aviation Oil and strengthen risk controls, the banking regulator argued.
Last weekend, the CBRC also issued a 13-point circular to banks on how to control lending risks better, with instructions related to strengthening internal checks and ensuring that employees do not gamble or take drugs.
"The weak ability to handle risk in bank operations has become increasingly prominent in the development of the banking sector," the commission said, "for example, in some banks there are inadequate rules, no proper supervision of the implementation of those rules, lenient punishment for violations, weak management and poor internal controls, all of which lead to major problems."
In an important related development, the government has also announced it will stop subsidizing bankrupt state-owned firms within four years, a move seen as helping lenders to stave off political pressure to disregard risks in issuing loans.
The Chinese banking sector is still confronting an unenviable legacy of financing more than 170,000 economically inefficient state-owned enterprises (SOEs). The scale of the problem remains evident in the substantial level of residual non-performing assets still on the books of the country's banks.
Yet, in recent years, the authorities have tried to clean up the problem, developing a commercially orientated sector that will be able to face increase competition from foreign lenders when the market open after 2006, as agreed with the World Trade Organization.
China's banks had $3.8 trillion of assets at the end of 2004, according to the banking regulator.
Ernst and Young's recent "Global Nonperforming Loan report 2004" suggested that China has seen a gross disposal of $200 billion since the establishment of four asset management companies in 1999. Of that $200 billion, $107 billion are still with the AMCs, meaning that a net $93 billion has been resolved through "restructuring, reclassification, repayment, or write-offs."
Bank of China and China Construction Bank, the second and third biggest lenders, received a $45 billion government bail-out in December 2003 to help them re-organize and prepared for planned Initial Public Offerings.
The latest corruption scandal at Construction Bank is a dampener for the IPO, which is expected to raise $5 billion. But central bank governor Zhou Xiaochuan said the fraud cases won't delay the government's plan to sell shares in them.
Meanwhile, the Industrial & Commercial Bank of China, the largest lender, is pushing ahead with its reorganization into a joint-stock company in preparation for a record $10 billion IPO.
It has hired China International Capital to advice on the reorganization of its $640 billion of assets, and may receive a government bailout of as much as $35 billion to bolster its finances.
Macquarie's So believes that in light of the recent scandals, investors will be "quite cautious" about the quality of assets of the banks trying to list.
"They will look closely at accounts and management problems. There could be a discount to the rating of the bank, compared with the past," So said.
