China’s banking system has a paper problem. It uses too much of it. In today’s realtime-tracking systems and continuous risk calculations and cross-market arbitrage algorthms, much of China’s $700 Billion financing market is funded through paper loans. In one incident late 2015, Citic Bank, one of China’s major banks, discovered a fraud scheme that approved $150 Million of approved loans using a financial instrument called Banker’s Acceptance. This is a short term loan that does not need to meet all of the stricter requirements of a traditional loan. This fraud was done through the production of fake documents.
As a result, China Banking Regulatory Commission publicly asked banks to review their banker’s acceptance bills financing instruments. This is in the face of an industry with little domestic competition, and, therefore, no real need to manage risks. For that matter, the domestic operations of Chinese banks is quite archaic. Only one in five loans are done electronically. This often means, loan proceeds are given to borrowers before a complete review has been completed.
The problem here is two fold. There is the direct problem, which is that the industry needs to have a regulation that requires full reviews, and, hopefully, will pressure banks to make their loan application and review process be more electronic. And then there is the systemic issue. With every bank essentially acting as an arm of the central bank, there is no competitions, so, there is no motivations to compete. Without such competition, why should any executive risk the bank’s operations with costly and unproven improvements? There is very little upside.
The irony is that Chinese bank operations in other countries, like the US are highly risk averse. They more risk averse than their Western counterparts.
Marcus Maltempo is a Certified Anti-Money Laundering Specialist and a Certified Fraud Examiner with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.