Huarong debacle turns spotlight on hundreds of Chinese banks

BEIJING • Lai Xiaomin, the former chairman of China Huarong Asset Management, was found guilty of accepting US$277 million (S$369 million) in bribes, as well as bigamy - crimes serious enough to see him summarily executed in January.

Such extreme behaviour and consequences are rare in any country. But in China, more modest but still flagrant mismanagement is common in the US$54 trillion financial industry.

Last year alone, the country's top banking regulator issued almost 3,200 notices for violations against institutions and 4,554 against individuals ranging from senior executives to rank-and-file staff; it levied fines totalling 2.3 billion yuan (S$470 million). In the US, which has a much longer history of bank regulation, the Federal Reserve took 58 enforcement actions in total.

Among the infractions, Chinese investigators found fabricated financial statements, executives' nannies and chauffeurs installed as controlling shareholders, and favourable rates and sweetheart deals for investors and relatives.

The state has also bailed out three poorly run small lenders and merged dozens more since its first crackdown three years ago. Still, out of 4,400 financial institutions, 12.4 per cent are designated as at high risk of failure by the central bank. Now, the government is rewriting the commercial banking law and will have "zero tolerance" for transgressions.

"Poor governance is obviously a risk for financial stability," said Ms Alicia Garcia Herrero, chief Asia economist of Natixis. If it is contained within the country's smallest institutions, the potential for damage is minimal. "The issue is that we don't really know whether governance problems are really contained and this is the big risk."

The past week offered a fuller picture of the costs of mismanagement and unchecked corruption. Huarong, which has around US$42 billion in outstanding debt at home and abroad, delayed its earnings report early this month, beginning a spiral that has seen its bonds fall to a record low of about 52 US cents on the dollar. Its shares are down 67 per cent since the 2015 debut and currently suspended.

A China Huarong spokesman said on Thursday that the company "learnt the lesson from Lai Xiaomin's case, firmly implemented central government policies, continued to eliminate the toxic influence, restored our corporate governance, accelerated business transformation and management reform, and enhanced corporate governance to move towards stable and better development".

It is the second time in two years that creditors have been left at the mercy of bad actors. In 2019, China jolted global markets with a surprise seizure of Baoshang Bank, once seen as a model for funding regional economies.

Triggered by the misappropriation of funds by its controlling shareholder, the takeover and eventual bankruptcy of Baoshang also called into question long-held assumptions of a perpetual government backstop.

In general, the China Banking and Insurance Regulatory Commission (CBIRC) has placed the blame for problems in the financial system on bank directors, shareholders and executives, saying in a December statement that "ineffective corporate governance is the root cause".

In one example, a rural bank lent the equivalent of 95 per cent of its net capital to its shareholders and affiliates, according to the CBIRC, which did not name the bank. Most of those loans defaulted or are non-performing.

The largest shareholder at one bank inflated revenues by 80 million yuan to make the institution look profitable. Elsewhere, one person and 22 of what the regulator described as his "shadow affiliates" held stakes in 17 banks, far exceeding the limits on banking ownership.

The regulator has also identified bad behaviour in its own ranks, putting its official in charge of oversight of the rural banks under investigation.

"This is work in progress," said Mr James Stent, author of China's Banking Transformation and a former banker who has spent more than a decade on the boards of two Chinese lenders. "Governance is generally good at priority large banks, but problems remain at lower-level financial institutions. Addressing them will take time, and governance will always be imperfect."

BLOOMBERG