In China, Fraud Adds to Bank-Stock Volatility: by James T. Areddy in The Wall St Journal, Fe 12, 2016

Stock markets around the world are pounding bank stocks on concern their basic business is under threat. There’s an added concern about banks in China: how the stock-market falls may be exposing fraud in their operations.
Bank stocks are under pressure world-wide over investor concerns that their profit margins are at risk as more central banks move toward negative short-term interest rates. U.S. banks got hit anew after U.S. Federal Reserve Board Chairman Janet Yellensaid negative short-term rates should be considered.
In China, while negative interest rates don’t appear to be on the central bank’s near-term agenda, banks’ profit margins are being pressured as the interest rates have gotten cut and bad debts rise. Yet, another factor lurks in the background for China’s banks: fraud of the kind that results from banks’ lax internal controls that floats to the surface when stock markets tank – as China’s has.
Two major banks in recent weeks have said they are cooperating with police about massive scams that appear to share characteristics.
In late January, Agricultural Bank of China Ltd. described a “material risk incident” at its Beijing branch involving tradable notes worth 3.915 billion yuan, around $595 million.
A few days later, Citic Bank Corp. issued a statement saying it was assisting police in an investigation of fraud at its branch in Lanzhou involving bills valued at 969 million yuan, or $147 million.
Neither bank has elaborated but analysts took note of the brief stock-market statements to remind investors of the risks of fraud in China’s financial system. “We think the reported incidents would have a minor impact on the banks although they highlight operational risks and contagion risk from financial market volatility,” analysts at Goldman Sachs in Beijing said in a statement at the time.
Bills, also called notes or bankers’ acceptances, are unsecured short-term IOUs, often from small businesses, which are traded among banks. Bill fraud can take many forms. One common play is for bankers to lend fake IOUs to other bankers to raise cash. The cash might then be invested in the stock market for a quick profit before the trade is reversed; but tumbling stocks makes it likelier the fraud will come to light as fraudsters can less easily cover their tracks.
“In the next few months, we believe more risk events cannot be ruled out due to higher credit risks in general, short maturity of bills (3-6 months) and A-share volatility,” said the Goldman report.
Chinese authorities have said since last year’s stock-market collapse that they are on the lookout for fraud. Shortly after the bank statements, China’s anticorruption watchdog agency, the Central Commission for Discipline Inspection, said it discovered widespread problems in the financial industry, including among state-run banks and their regulators. In response, the China Banking Regulatory Commission said its shortcomings limited its ability to perform market oversight.
The watchdog was light on specifics about the problems it saw in the financial industry but indicated many violations related to political concerns: Officials of Citic Group, which controls Citic Bank, for example, were accused of “talking about business too much while seldom talking about the Party.”
Agricultural Bank, which late last year had already reported the departure of a top official amid a corruption investigation, issued a statement related to the commission finding that said it wasworking hard to address party-discipline issues.
While analysts said they are watching for signs of fraud at Chinese banks they played down the immediate impact of the statements from Agricultural Bank and Citic Bank for the banks individually and the banking system in general.
Standard & Poor’s said the problems cited by Agricultural Bank, for example, would impact only about 0.3% of its equity as of last September.
“While this incident may call into question the effectiveness of [Agricultural Bank’s] internal controls, we view corporate governance and transparency in the Chinese banking industry as a weak spot and have already factored this assessment in our banking industry country risk assessment on China,” S&P said. “We also noted [Agricultural Bank’s] patchy track record in this regard, particularly before its financial reform in 2008.”
After Citic Bank’s warning, S&P analyst Chris Lee said by email that the possibility of “such irregularity” is already reflected in its anchor ratings for Chinese banks. http://blogs.wsj.com/chinarealtime/2016/02/12/in-china-fraud-adds-to-bank-stock-volatility/