Tighter regulation of Chinese banks’ bill financing could trigger stock market panic, analysts say

Police have launched investigations into fraud cases at Agricultural Bank of China and China Citic Bank

PUBLISHED : Tuesday, 02 February, 2016, 8:48am
UPDATED : Tuesday, 02 February, 2016, 9:38am

Chinese banks’ bill-financing business could be in the eye of a storm.

With police launching investigations into a series of massive fraud cases involving insiders illegally obtaining the bills to invest in stock markets, analysts say a possible tightening of regulations could reduce liquidity in money markets and trigger a panic in stock markets if more cases are exposed.

China Citic Bank, a banking subsidiary of giant conglomerate China Citic Group, recently revealed a 969 million yuan fraud case. An employee in the bank forged documents to acquire a bill and sold the bill multiple times in order to invest in the once-sizzling stock markets. But the employee was caught in the fourth quarter, media reported, after the Chinese stock markets plunged from a seven-year high in June.

Agricultural Bank of China, the country’s third-biggest lender by assets, confirmed a similar fraud case last month. Media reports said two employees of the bank illegally sold 3.9 billion yuan worth of bills to obtain cash and invest in the stock markets, but failed to fill the gaps after the markets slumped in the second half of the year. The bank discovered the bills in the safe box had been replaced with newspaper, Caixin reported.

Both China Citic Bank and Agricultural Bank said in separate exchange filings that the police had started investigations.

We believe implications for the broader financial market could be more significant as a result of potential tightening of underwriting standards
Goldman Sachs

A bill, also known as banker’s acceptance, is a money market instrument commonly used for short-term corporate financing. It can be sold at discounted prices before its maturity, which is up to six months.

The incidents were exposed shortly after the China Banking Regulatory Commission (CBRC) urged banks to strengthen internal risk control in the bill-financing business at the end of December. The CBRC also said it would “tighten” relevant regulations to avoid systemic risks.

The regulatory move and the exposure of the incidents have led to a spike in money market borrowing costs. From January 22 to January 29, the bill interest rates in the Pearl River Delta area and Yangtze River Delta increased by 13 basis points, to 3.73 per mille in the south and 3.68 per mille in the east, according to data from Industrial Securities.

Analysts said the spike in bill interest rates was mainly due to worries over a potential overhaul of the industry and further exposure of such events, rather than the incidents alone.

The incidents may have limited systemic impacts, as the total risk exposure only accounts for 1 per cent of Agricultural Bank’s outstanding loan loss reserve at the end of the 2015 fiscal year and 2 per cent of China Citic Bank’s, Goldman Sachs said in a research report.

“(However), we believe implications for the broader financial market could be more significant as a result of potential tightening of underwriting standards for the bankers’ acceptance business and higher risk aversion among financial institutions in money markets,” analysts from the investment bank said.

More risk aversion, compounded by potential capital outflow and seasonality, could result in a tightening of financing conditions, especially for small and medium-sized firms, they said.

In the next few months, more risk events “cannot be ruled out”, due to higher credit risks, short maturity of the bills and A-share market volatility, Goldman forecast.

Analysts from Citic Securities had similar opinions.

They said the incidents had attracted wide investor attention, because they worried that if too much of the funds in the stock market had come from those bills, a potential overhaul might cause “sell offs”, leading to heavy falls in the stock market similar to the one in the second half of last year.

Although “massive sell-offs” may be unlikely due to the shrinking size of bill discounting after July, the negative impact of the potential overhaul on interest rates and investor sentiment should not be ignored, Citic Securities said.

“We think enterprises may have more trouble raising funds through bill discounting as the direct discount rates go up,” analysts from the securities firm said.

In addition, investor sentiment had remained weak after the market collapsed last year, with A-share markets plunging further in the first month of 2016.

Further exposure of such events could “create more panic in the market and dampen risk appetite”, they added.