China’s regulators are tightening scrutiny of the nation’s multitrillion-yuan note market after prominent banks reported three fraud cases this year, exposing the weak internal management of mainland banks. A note is issued by a bank promising to pay a specific sum to the bearer on demand. The bearer may cash the note with another bank but at a discount. Notes can be traded on the interbank market as well as on the grey note market. Banks have been told to conduct an immediate and comprehensive inspection of their notes businesses, strictly check the real business need behind the bills, and improve internal management, to weed out irregularities that have resulted in several fraud cases this year, industry sources said citing a circular issued by the People’s Bank of China and the China Banking Regulatory Commission at the end of last month. The banks have been told to run a check on the bills of exchange business before June 30 and report the findings to the regulators by July 15, said one source. Three prominent banks – Agricultural Bank of China (ABC), one of the ‘big four’ state-owned lenders, Citic Bank and Tianjin Bank – have announced note risks involving a total of 5.65 billion yuan (HK$6.75 billion) since January. In ABC’s case, two employees stole notes worth 3.9 billion yuan to invest in China’s stock market in early 2015. After they failed to recoup the money as a result of the market rout in summer, ABC found the notes replaced by newspapers in the bank safe. “The recent bout of frauds is pushing the authorities to tighten inspection,” said a Shanghai regulatory source who did not want to be identified. “In Shanghai, banks have already been ordered to check bills of exchanges more meticulously, including making sure if the bills actually exist.” Another industry source said local financial regulators are to start a comprehensive investigation into the agencies trading notes. Xin Yueliang, chief executive of Piaobaobao.com.cn, an agency based in eastern China’s Shandong province, said the bills market has been chaotic for years, with illegal agents faking notes and colluding with bank employees to embezzle funds. “I get a clear sense that the authorities are toning up supervision. The key is within banks’ internal management. If banks maintain strict compliance, the illegal agents won’t survive,” he said. He also said electronic notes could go a long way in tackling the problem. “It is almost impossible to fake an electronic note. And, it’s impossible to replace it with newspapers too,” Xin said, adding half the notes trading on his platform are electronic. Some analysts believe the current crackdown may affect liquidity. “It may cast a shadow on liquidity as it is difficult to know the real scale of irregularities and how the crackdown will hurt liquidity,” said Hong Hao, chief strategist at BoCom International. “In a way, the liquidity issue may be more important as it will have spillover effects on the real economy,” said Hong. A senior note trader, who did not want to be named, however, said the turnover on China’s note market runs to more than 10 trillion yuan a year and only a very small portion of it is problematic. “The note business is usually strictly insulated from a bank’s core business. Even with these recent cases of fraud, it is unlikely that the money is not traceable,” he said.