Insider threat presents systemic risk for corporates in China

Several high-profile financial scams in Chinese banks have demonstrated the threat posed by insiders. This presents complex compliance risks for corporate governance. 

Case studies

On 27 January, the China Banking Regulatory Commission (CBRC) fined 12 Chinese banks for illegally trading bank bills worth RMB7.9 billion (USD1.25 billion). It handed the largest fine to state-owned Postal Savings Bank of China (PSBC), one of the country’s largest retail lenders. The illegal trading was discovered in December 2017 at a PSBC branch in Wuwei city in the western Gansu province. The branch manager had forged 147 discounted notes, a type of short-term debt bills, with a combined value of RMB7.9 billion, and sold them to other financial institutions, including Jilin Jiaohe Rural Commercial Bank, for an unspecified price. In addition, he subsequently issued RMB3 billion of fraudulent wealth management products to buy the notes back.

According to the regulator, PSBC employees colluded with ‘outside conspirators’ to fabricate licences and contracts as well as forge the company’s seal. Registered companies in China are required to have an official company stamp and any agreement with this stamp, regardless of who used it, is legally binding.

PSBC employees colluded with ‘outside conspirators’ to fabricate licences and contracts as well as forge the company’s seal

In a separate case, regulators imposed a record-breaking penalty totalling RMB722 million against China Guangfa Bank in December 2017 for providing illegal guarantees for corporate bonds. Guangfa is a major regional bank in the southern manufacturing city of Guangzhou. Investigations revealed that staff in its Huizhou city branch had used counterfeit company seals to sign off fraudulent documents guaranteeing bonds worth RMB1 billion. This arrangement came to light when the bonds went into default, forcing Guangfa to turn to 13 other banks to borrow a total of RMB12 billion to resolve the issue. The regulator blamed weak internal controls and an unhealthy incentive system for the violation.

China’s third-largest bank was embroiled in a similar incident. In November 2017, regulators fined the state-owned Agricultural Bank of China (ABC) RMB19.5 million over an embezzlement case in 2016. Two junior bank employees in its branch in the capital Beijing had forged bills of acceptance to obtain RMB3.8 billion in cash to invest in the stock market. They had intended to return the money after the stock trade but failed to do so when the market hit a sharp downturn. The incident suggested the bank has learned little over the past decade; in 2007, two vault managers at an ABC branch in Hebei province embezzled RMB51 million.

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Insider threat in corporate China

While these cases all occurred in the domestic banking sector, the risk is neither confined to Chinese companies nor to a specific industry. Instead, a vast array of fraudulent schemes exists in China with varying degrees of sophistication. They could involve minor instances of expense skimming, for example through overinflating meal and travel expenses, or more complex schemes, such as accounting fraud, as well as vendor, supplier and procurement fraud. Mainland China exhibits very high levels of asset appropriation and fraud committed by joint venture partners, agents and intermediaries.

The proliferation of these schemes reflects a weak risk management culture that is systemic across Chinese corporates and management. In a 2016 survey of multinational companies with operations in mainland China, 86 per cent of respondents claimed to have been affected by fraudulent activities within the previous year, an 18 per cent increase from 2015. In the same survey, insiders were identified as primarily or partly responsible for 82 per cent of cases.

The proliferation of these schemes reflects a weak risk management culture that is systemic across Chinese corporates and management

While the West regards compliance as a dull but necessary evil, many senior Chinese managers view it as producing few tangible benefits to the business at all, allocating it minimum resources just to meet basic requirements. This attitude is also evident in a 2016 poll by professional services company EY. About 56 per cent of Chinese executives surveyed said that unethical behaviour, including misstating financial performance, is justifiable if it helps the company through a difficult period. These attitudes have contributed to a general business climate where weak internal controls are the norm.

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