Caixin
Oct 27, 2011 09:47 PM

Deposits In, Illegal Loans Out

The phone rang late July 19 at the home of Zhang Fenghuai, president of the Bank of China's Inner Mongolia Branch, and his wife answered.

A voice on the phone told her that a deliveryman with a package was standing outside the front door of their Hohhot home, waiting.

She went to the door. Then she disappeared.

Zhang soon received a bizarre demand from his wife's kidnappers: He was told to pay a 200 million yuan ransom to win her release or, alternatively, rehire for three months three ex-employees who'd been sacked by his Hohhot bank.

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The drama ended the next day when police rescued Zhang's wife and made five arrests. Among those charged was a woman named Tu Ya, the alleged leader of the kidnapping ring.

Yet the crime saga continued as investigators from local police looked for the motives behind the case of Tu and the banker's abducted wife. They eventually uncovered a complex scheme that over several years was used to systematically drain cash from personal bank accounts across Inner Mongolia, sometimes in cooperation with account holders, for speculative investing and illegal lending at high interest rates.

Authorities learned that Tu, with help from bank insiders, had secretly siphoned money from various branches of BOC, Agricultural Bank of China (ABC), Baotou Commercial Bank and at least two other banks. They also learned that some bankers tried to cover up the crimes to hide their own financial mismanagement and the fact that savings withdrawals have accelerated in recent months as clients sought higher yields.

BOC's Zhang was among the executives who caught on and fired several employees for participating in the scheme. Among those sacked were the three whom Tu wanted rehired in exchange for the kidnapped wife's release.

Tu hatched the abduction in a desperate attempt to re-start her illegal money pump, sources told Caixin.

"Tu kidnapped Zhang's wife because BOC suddenly took action" against the thieves "leading to the collapse of her capital chain," said one informed source. That chain had funneled much of the cash from bank accounts to private borrowers willing to pay high interest rates.

The private sector has been craving capital from any source, even at exorbitant rates, since central government monetary tightening started drying up bank credit last year.

A source at the central bank told Caixin that the private sector has been pinched not by a lack of liquidity but due to unbalanced capital flow. The scheme involving Tu, her accomplices and the banks points to an extreme example of this imbalance.

After the kidnapping was foiled, several Inner Mongolia banks conducted internal probes and discovered funding problems tied to weak, back-office risk and compliance management. Some discovered that illegal money-moving had gone on for years due to serious personnel and account monitoring flaws.

Bank Cracks

Financial oversight has generally improved at state-owned commercial banks in China over the past decade, in part because they've reformed shareholding structures and listed on stock markets.

But people in the banking industry says these financial controls have often failed to counteract criminal activity targeting banks. Crimes have included illegal fund-raisers at bank branches involving corrupt insiders working with criminals outside the banks who find ways around bank controls.

Central government financial regulators have shown themselves aware of the cracks in the security of deposits at local bank branches around the country.

As far back as six years ago, China Banking Regulatory Commission Chairman Liu Mingkan spoke of "grassroots" level dangers, and said bank-related crime in China is characterized by three "80 percents."

Bankers with supervisory powers account for 80 percent of the  crimes, Liu said, and 80 percent of the illegal activity involves branches at the grassroots. The third characteristic, he said, is that 80 percent of the crimes involve back-door collusion between bank insiders and criminals.

An executive at a large, state-owned bank told Caixin that the suspects linked to the Inner Mongolia fraud case built a "ghost" financial platform and, with help from bank employees, fed it with funds funneled from deposits. Aiding the scheme was the fact that banks have been scurrying to attract new deposits over the past year.

The executive said the Inner Mongolia gang is only one of "many such cases around the country. But a lid was kept on most.

"Thanks to the kidnapping," he said, "the practice was brought to light."

The scramble for new deposits has been the bankers' reaction to  an accelerating flow of money out of the nation's savings accounts nationwide in recent months. One reason for the migration is heavy demand for non-bank loans even at high interest rates.

Between September 1 and 15, the nation's Big Four banks -- BOC, ABC, Construction Bank of China, and Industrial and Commercial Bank of China -- reported a combined decline of about 420 billion yuan in outstanding deposits from August.

The Big Four added only about 87 billion yuan in new loans during the first 15 days of September.

The money migrating from banks is apparently being channeled by other types of financial service firms into high-rate lending.

"Some local guarantee companies, investment companies and consulting companies have aggressively engaged in the high-interest loan business," said an official at China's banking regulatory body, who asked not to be named. "Banks sit on the largest sources of funds and credit, and their staff members can easily be targets for illegal fund-raising.

Fraud Alert

The three workers were canned by Zhang's branch in Hohhot after the major account monitoring system at BOC's headquarters detected in June abnormal activity involving more than 40 accounts in Inner Mongolia. Headquarters ordered the region's branches to investigate immediately, leading to staff changes.

Exactly how much money was drained from targeted bank accounts appears to be a mystery. According to information Caixin obtained from anonymous bank customers, the amount stolen was no less than 2 billion yuan and may have been as much as 6 billion yuan.

It appears accounts were tapped in a way that allowed any single theft to remain undetected until a depositor tried to make a withdrawal.

BOC and ABC officials have called theft levels "not so high," but so far they've refused to discuss what investigators found.

The source said investigators with the Inner Mongolia Public Security Bureau traced the thefts to at least five banks, and prosecutors have approved the arrests of at least nine people including Tu and four alleged kidnappers. Another four face charges for taking bribes.

Trouble at Zhang's bank, detected by BOC's head office in June,  was tied to more than 40 accounts.

How did bank staffers and Tu move money? A source said Tu established her own, illegal financing platform and leveraged the good reputation of established, state-owned banks such as BOC.

A bank source said she created a kind of Ponzi scheme by borrowing new money to pay old loans.

The first step involved offering to help individuals open new savings accounts at a bank such as BOC's Hohhot branch. To attract savers, she offered to pay additional interest -- sometimes 50 percent -- to depositors on top of normal bank interest.

Bank employees who agreed to work with Tu would transfer depositor funds out into Tu's ghost accounts, which would then use the cash for speculative investments. The insiders also won favor from their superiors by helping attract new deposits.

Bank deposit certificates were issued to initial clients, thus giving Tu and her insider contacts a measure credibility among the depositors, who felt convinced that their savings were safe and that any money lost through speculation would be covered by the bank.

To cultivate contacts inside banks, Tu pretended to be an easy-going, wealthy client.

One bank worker who confessed to being a Tu accomplice, a woman named Tonglaga, won the trust of her superior after Tu deposited a large sum of money.

Tu then gave Tonglaga the account password, said an investigator, and instructed the bank worker to move money in and out of the account.

This kind of client-banker relationship and money transfer behavior is illegal but apparently not uncommon at banks across the country when bankers want to please wealthy clients, said sources in the banking industry.

Tonglaga signed a contract with Tu that set a commission scale for her help in arranging deals. In addition, Tu gave Tonglaga and her fiancée, who worked at Baotou Commercial Bank, an apartment, thus opening a back door to that bank's accounts.

Bank employees such as Tonglaga and her fiancée secretively transferred money in and out of their banks, a source said, or borrowed a client's deposit certificates for periods of time, usually six months. The money could be used to issue private, short-term, high-interest loans.

Tu gradually expanded her network to several banks after cultivating personal relationships through established bank insiders.

The BOC personnel shuffle in June, though, led to the collapse of Tu's financing chain.

After cracking the kidnapping case, authorities froze accounts controlled by Tu and her cohorts. On September 21, banks in Baotou were notified by banking regulators that investigators were targeting 30 people and more than 40 accounts.

The notices did not spell out the reason for the probe, but the financial community understood its connection to BOC, Baotou Commercial Bank and ABC.

A letter sent to Caixin by an anonymous bank customer said Tu's "model" had been used at ABC's Inner Mongolia branch for at least five years. Tu became an ABC business partner in 2005, but was forced to transfer the scheme to BOC after officials at ABC cleaned up their financial practices to prepare for a stock market listing in 2009.

The source said a recently appointed president for ABC Inner Mongolia worked with police to investigate Tu.

Now that the fraud has come to light, scores of bank clients with good reason to worry about their capital have chosen to lay low. Some were apparently aware of Tu's maneuvering but said nothing because they were promised high returns, which they didn't want to jeopardize by blowing the whistle. Now, though, they may have to pay back those illegal profits.

A legal source said the police will now seek "to recover the high returns that were already paid to depositors. Such behavior is illegal, and the returns are considered ill-gotten gains."

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