Bank 'milling' scandal bound to be replayed again and again

PUBLISHED : Saturday, 15 January, 2011, 12:00am
UPDATED : Saturday, 15 January, 2011, 12:00am

Deja vu. A decade after some listed state-owned firms told the market that significant bank deposits - the safest of all investments - were in danger, another case has emerged.

On Thursday, Sinotruk (Hong Kong) announced that a 500 million yuan (HK$588 million) bank deposit by one of its subsidiaries was found to be related to a financial note forgery case, and 'certain defective deposit slips' had been located. That was two days after mainland media named the Shandong-based heavy truck maker as one of the victims of the Qilu Bank scandal.

Sinotruk provided no details. Nor will it comment on the reports.

According to Xinhua, in its investigation of Qilu Bank, police have found fake deposit slips. A man allegedly has been using fake slips to get significant loans. Various banks and companies were involved. All Sinotruk would say was that the affected deposit was with a bank that is involved in a financial forgery case and judicial authorities are working on the case.

The exact facts of the Sinotruk case remain to be disclosed. Whatever they may be, the so-called 'milling' practice is an open secret on the mainland. The first thing you need is an agent who, very often, is a former banker, so he is well connected with local banks and corporates, and knows who has cash - and who wants it.

He hooks up the cash-rich corporate and the deposit-hungry banks. The corporate makes a deposit; the agent gets the endorsement to use the deposit slip as collateral; the bank lends him money; he deposits the money with other banks for a bigger loan; and then lends the money to some private entrepreneurs at loan-shark rates (see diagram). The mill can go on and on. Every party has some goodies to gain.

The corporate gets a deposit rate significantly higher than the official level.

'Instead of 2.5 per cent, you can get somewhere around 6 [per cent] in various forms of rebate,' said a mainland banker. Some kickbacks to its finance people are accepted. The provincial and city banks that have a tough time competing with their mega rivals for deposits are thrilled to get the money in. With controlled interest rates and therefore guaranteed interest spreads, a bigger deposit base means an even bigger loan book and bigger profits.

No wonder its bankers or so-called relationship managers have their bonuses tied to the amount of deposits they can bring it. To the bankers, a well-connected middleman is an angel. The banks are also happy to see loans to the middleman, who is paying above the official ceiling as an individual. 'That can go as high as 8 per cent,' said the banker.

As for the middleman, he charges private businesses no less than 20 per cent and pockets the difference. The money is expensive, but private entrepreneurs don't have much choice in a country where banks have a bias towards state-owned companies.

As long as private entrepreneurs are doing good business and keep paying interest, everybody is happy. Given the juicy returns, the emergence of fake deposit slips somewhere along the way is almost inevitable.

But isn't the risk too obvious for the corporate and banks to miss? Well, we're talking about a regulatory regime that has distorted pricing, returns and therefore risks. 'This kind of scheme was there in the '90s. The only difference is that small provincial or city banks have replaced the big boys,' said a former financial controller of a state-owned enterprise.

Also, let's not forget that the government has been actively boosting lending to stimulate the economy for more than 14 months. The risk has been tolerated by the regulators. The growth in deposit slip financing can be seen in many banks: newly listed Chongqing Rural Commercial Bank is a good example.

The size of a deposit as loan collateral grew 197 per cent in 2009 and 59 per cent in the first six months of last year. That's way above its loan growth of 40 per cent and 8.9 per cent in the corresponding periods.

There are hurdles in the deposit slip scheme - a responsible auditor. In the case of Qilu, PricewaterhouseCoopers questioned why the banks had made significant loans to individuals with little financial strength, other than some deposit slips.

The solution? Qilu fired Pricewaterhouse-Coopers and the regulator has said nothing about that. Given the scandal, one can be pretty sure that the regulators will do something about it now. Borrowing with deposit slips will be tightly controlled. That's what they did after the 'trusted loan' scandal in the late 1990s.

State-owned enterprises, including some listed in Hong Kong, deposited billions worth of yuan with banks in the form of 'trusted loans'. The banks then dished out the money to various private enterprises at hefty rates agreed by the depositors. As the economy slowed, the loans were not repaid. Yet, with the pricing distortion intact, we are going to see this replayed again and again.