China's Banks under a Cloud

Scandal at Bank of China highlights questions about China's Big Four

For more than a decade, Wang Xuebing shone as one of the brightest stars in the often dark sky of the Chinese financial world. In 1993, he took over as head of Bank of China, the country's second-largest, and two years ago began running another of the Big Four banks, China Construction Bank (CCB). He was part of an elite cadre of officials singled out by Premier Zhu Rongji and given the task of restructuring China's tottering state-owned banks. Indeed, as an official with Cabinet-level rank and as an alternate member of the Central Committee of the Communist Party, Wang stood at the pinnacle of power in Chinese financial circles.

Now, in a case that is roiling Chinese finance, Wang has been fired from his post and detained on suspicion of corruption--a charge that could result in the death penalty. On Jan. 11, after repeated denials from China Construction Bank officials that anything was amiss, the Chinese government confirmed rumors that Wang had been removed as head of the bank.

People in China and Hong Kong familiar with the situation say that Wang is being investigated in connection with a questionable $23 million loan linked to his wife. The loan, say sources, was arranged through Bank of China's Hong Kong office in 1994, when Wang was in charge. The loan was secured by vastly insufficient collateral, and was not repaid--until the bank itself covered the cost of the credit through its New York office. Because of the American connection, the affair is also being investigated by U.S. authorities. BusinessWeek has learned that Bank of China may soon sign off on a deal to settle the matter by paying a fine of more than $10 million to the U.S. and to the People's Bank of China (PBOC), the central bank.

Wang did not respond to requests for an interview and did not answer a detailed list of questions sent to him. At a Jan. 15 press conference, PBOC Governor Dai Xianglong confirmed that Wang had been removed from his job and that a probe was under way: "Wang Xuebing had direct responsibility for loan cases that happened in some individual Bank of China branchesthe relevant departments will continue investigating the problem of comrade Wang Xuebing."

The case promises to have repercussions well beyond the fate of Wang. Bank of China had planned to list its highly profitable Hong Kong and Macao operations on the New York and Hong Kong stock exchanges by the middle of the year, and could now face a more difficult job finding investors. "This will heighten investor skepticism and raise questions," says a financial-industry executive in Hong Kong. "The IPO will not be successful unless these questions are answered." The landmark deal, expected to raise between $2 billion and $5 billion, would mark the first time one of China's Big Four banks--the other two are Industrial & Commercial Bank of China and Agricultural Bank of China--has tapped international equity markets. Goldman, Sachs & Co., UBS Warburg, and Bank of China International--BoC's Hong Kong-based investment-banking arm--are the lead underwriters.

The Wang case is the latest in a series of scandals that underscore the banking sector's weak controls. The PBOC said early this month that it was censuring all of the Big Four banks, which control two-thirds of the country's banking assets, and punishing 686 members of their staffs. The move is part of a seemingly never-ending effort to root out bank corruption by conducting sweeping investigations and crackdowns. The central bank said it found "a serious breach of rules" at more than 100 bank branches. It also closed 1,585 post-office bank branches for various infractions.

At the Bank of China, Wang's reputed offense pales in monetary terms beside another recent scandal. Chinese and Canadian authorities are hunting for a number of ex-Bank of China managers who they believe stole a staggering $480 million from a Guangdong branch between 1992 and last year. Hong Kong police say three of these suspects have fled to Canada. Court documents filed in Vancouver indicate that Chinese authorities suspect that at least $75 million was transferred out of China. The most recent transfer, of $6.27 million, was made to three different banks in Canada in mid-October. No arrests have been made.

Meanwhile, in September, 2000, Cheng Kejie, a powerful provincial politician and a vice-chairman of the Standing Committee of the National People's Congress, was executed for taking $5 million in bribes to help arrange loans from Bank of China and China Construction Bank. Another official in charge of Bank of China foreign-exchange operations committed suicide in May, 2000.

The charges against Wang are especially bad news for the stock listing because they involve the Hong Kong branch. At least one key meeting concerning the suspect $23 million loan took place at the bank's glittering 70-story Hong Kong headquarters and involved a group of senior executives. The Hong Kong branch's First Deputy General Manager, Liang Xiaoting, was arrested late last year and is now being detained in Beijing along with Wang, according to several sources. Efforts to reach Liang were unsuccessful.

The idea of Wang's getting involved in such proceedings is shocking to many. Wang once had a reputation as one of China's foremost financial reformers who put a sharp focus on profitability. In an interview with BusinessWeek in February, 2001, Wang preached the need for banks to emphasize earnings over size. "When I asked questions about performance, [employees'] answers usually centered around loan growth," he complained. "My question is: How much profit are you generating for me?I don't think our employees understand the real importance of profitability and competitiveness."

Former employees say he was serious about instituting reforms. "He was a very nice man, very up-front and aggressive in terms of reform measures," says a former Construction Bank executive, pointing to stepped-up investment in upgrading CCB's creaky computer network and, oddly enough, toughening credit standards and building stronger internal controls. And Wang was no stranger to modern financial practices. He was also chairman of China International Capital Corp., the country's only international investment bank and a venture 34%-owned by Morgan Stanley Dean Witter & Co.

Wang's troubles apparently began back in 1995 with the publication of an article in the muckraking Hong Kong weekly, Next Magazine, about the $23 million loan. To this day, it is not clear exactly under what circumstances the money was borrowed or how it was spent. In the end, however, the loan, which originated in Los Angeles, was paid back not by the borrowers but by a new loan issued by Bank of China itself, through its New York branch.

A series of real estate documents examined by BusinessWeek show that a Taiwanese singer, Steven Liu, and his actress wife, Nicole Chang, assembled 16 parcels of land in Riverside County, California, between 1986 and 1990, paying $1.65 million. The Bank of China's Los Angeles branch apparently valued them at much more, since on Oct. 20, 1994, it extended the $23 million loan to Liu and Chang, secured by the properties. Less than two months later, on Dec. 15, a corporation that sources say was one-quarter owned by Wang's wife, Zong Lulu, bought the properties for $1.5 million. Chinese investigators suspect that Wang was involved in arranging the loan and that some of the proceeds ended up in his wife's hands. Later, Bank of China's New York office repaid the loan after Next Magazine raised questions about it, according to a person familiar with the investigation. Neither Liu, Chang, nor Zong Lulu could be reached for comment.

Initially, Wang deflected the charges by claiming that they were fabricated by anti-China forces trying to cause trouble in the runup to the 1997 handover of Hong Kong. Next Magazine is controlled by maverick tycoon Jimmy Lai, an outspoken critic of the Beijing government. But after the New York branch paid off the loan, disgruntled employees there brought this to the attention of U.S. regulators, who got in touch with their Chinese counterparts. After an investigation by the Office of the Comptroller of the Currency (OCC), which oversees banks, U.S. authorities threatened to close the bank's New York branch. Wang's successor as head of Bank of China, Liu Mingkang, flew to New York a year ago to negotiate. Since then, U.S. and Chinese regulators have been quietly hashing out a settlement. BusinessWeek's sources say the deal, which could be announced soon, will require Bank of China to pay more than $10 million to the OCC and the People's Bank of China. Officials at the OCC and PBOC declined to comment.

One of the stranger aspects of the tale is what happened to Wang. After U.S. investigators brought the matter to the attention of the Chinese, Beijing removed Wang from his post at Bank of China. But, apparently still unconvinced of the charges, in February, 2000, they installed him as president of CCB, China's third-largest financial institution. Political analysts say that Wang may have been able to keep his high positions because he was close to Premier Zhu Rongji. Though Beijing observers see his downfall as part of the runup to this fall's party congress, when replacements for Zhu and other top leaders will be named, the near completion of the U.S. investigation appears to be the main factor.

Beijing's willingness, however belated, to go after one of its most senior officials shows a continued desire to clean up its banking establishment. Moreover, in preparing Bank of China's Hong Kong and Macao operations to go public, a new centralized administration for that branch has been put in place. Eleven affiliated banks BoC ran in Hong Kong have been consolidated under one set of managers. And the entity to be listed on the New York Stock Exchange will be required to have independent directors and be subject to U.S. accounting standards.

But other Chinese banks will continue to rely more on moral suasion to police themselves than on a Western-style system of audits and government surveillance. That means rigorous and honest corporate governance will be a sometime thing. "China's economy is rapidly outgrowing its political and regulatory institutions," says Joydeep Mukherji, an analyst at Standard & Poor's in New York. "Continued reform depends increasingly on bringing institutions and practices more into line with international norms." But it could be years before effective new institutions to prevent massive fraud and theft are in place. Prospective investors in China's banks should heed the warning.

By Mark L. Clifford in Hong Kong, with Alysha Webb in Shanghai, Dexter Roberts in Beijing, and Petti Fong in Vancouver

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