Bank of China hit by new scandal

By staff reporters Duan Hongqing, Yu Ning, He Huafeng and Guo Qiong and intern Li Zhigang

obtained bankers’ acceptances worth up to 432.5 million yuan (＄53.8 million).

The scandal is just the latest in a series of stumbles for the state-owned baml as it prepares for a multi-billion dollar IPO in Hong Kong. The media exposed a scandal early last year involving the head of a Harbin BOC branch who embezzled several hundred million yuan. Since then, BOC, the second largest Chinese lender, has strengthened internal controls. 

On February 11th, a BOC sub-branch in the town of Shuangyashan in Heilongjiang announced in an internal banking publication that BOC was canceling 34 bankers’ acceptance bills. Those bills were discovered to be fraudulent when local businessman Zhu Dequan tried to cash them at other banks. Soon afterward, the head of the BOC sub-branch Hu Weidong, deputy head Wang Lin, and three other clerks involved were arrested. Zhu fled but was arrested in Changchun, Jilin Province on February 25th.

At the time of his arrest, Zhu was chairman of the Fuqiang Cereals and Oils in Shuangyashan City, Heilongjiang, and controlled another small flour mill in Shandong. Investigators found that Hu had helped Zhu obtain 96 such bills since March 2003, a total value of 914.6 million yuan (US＄113.8 million). Fifty-six of those bills were eventually repaid; the rest were cashed and incurred a 432.5 million yuan (＄53.8 million) loss for the bank. has verified that Zhu used the fraudulently obtained funds for futures speculation. Experts told that those bills are genuine and bear the official BOC seal; only they have circulated outside the official banking system.

Such fraud was once prevalent in the banking industry. Various attempts have been made to use bankers’ acceptance notes to speculate on the stock market since 2001. But such a relatively novice-level strategy should never have escaped banking regulators, who have become increasingly careful about bankers’ acceptance bills. Banks generally have strict checks and balances in place to avoid acceptance bill fraud. But the 96 bills involved in this particular case circulated, undetected, for two years.
 
Analysts say this has exposed serious regulatory loopholes. On the other hand, it also shows that ongoing banking reforms, focused on restructuring and risk management, are playing a role in curbing financial crimes. In fact, the Shuangyashan fraud surfaced just as BOC is implementing a rotation system for heads of its branches and sub-branches, to avoid “insider control” at the grassroots. Analysts say this signals the end of the lack of effective corporate governance in local branches.

The fraud underscores the loose management and lack of good governance in China’s financial sector, despite its strengthened efforts to root out corruption and control risk.

“It is unbelievable that such a small sub-branch can have issued so many bankers’ acceptance bills without arousing attention from higher banking authorities,” one local financial expert told .

There are detailed procedures for management of blank bankers’ acceptance bills. A sub-branch as small as the one in Shuangyashan must complete those procedures, register the issuance at a larger branch and get the signature of a designated clerk before being allowed to issue the bills. Once the bills are issued, higher banking authorities are obliged to supervise their use, and inter-bank checks are needed for repayment of bills valued at more than 1 million yuan (US＄124,380).
                                                               
The failure of the risk management system in this case has facilitated the crime of those banking executives and Zhu. Insiders told that Hu Weidong would tell his supervisors that some bills had expired, so that he could keep those blank bills.  The “expired” bills should have been collected and destroyed; but management loopholes made it possible for Hu to keep them and issue them to his accomplices including Zhu.

When Zhu and other businesses in the scheme try to cash the bills with other banks, the latter would need to verify their authenticity with the issuing bank, in which case it would again be Hu and his cronies who deal with them. Ideally, the accomplice businesses would repay the bills when they are mature; but once their cash flow breaks, the issuing banks would be exposed to grave losses.

“Even instinct would suggest that it is unlikely for a small county-level bank branch in an under-developed area to be continually issuing bills for so much money,” said one senior financial expert who declined to be named.  “Worse, it is even more implausible for such an obscure company as Zhu’s to cash bills for such huge amounts.”

In 2001, Zhu’s Fuqiang company was valued at 9.9 million yuan (US＄1.2 million), with liabilities of 9.34 million yuan (US＄1.16 million). It reported revenues of 4.4 million yuan (US＄547,260), but profits of only 2,000 yuan (US＄249), according to 2001 tax records.

Zhu earmarked the money he obtained from the bank for futures trading. “Initially, Zhu was rather cautious in the market, but gradually became reckless and incurred lots of losses,” a futures manager, who cooperated with Zhu for several months in 2005, told . He did not reveal how much Zhu had lost in the futures trading, but said the amount was “surprisingly large.”

Since the scandal, major banks have asked their local branches to strengthen their risk management systems.

English version by Xin Zhiming and Lauren Keane