China is sharpening its scrutiny of small banks' shareholders amid fears that loans from the lenders to big investors could prove a weak point in the country's financial system, jolted by the state's weekend rescue of one lender and recent takeover of another.
While nominally small, China's numerous small city commercial banks risk having outsized significance because of their close ties to the rest of the banking system as well as with bigger shareholders, many of whom are giant companies.
Earlier this month, the China Banking and Insurance Regulatory Commission (CBIRC) asked banks and some other financial firms for details of any investor building up stakes of 5% or more without required regulatory approvals.
The regulator also asked the firms if they had disclosed all business transactions with their main owners, according to a regulatory notice seen by Reuters.
Regulators have also conducted spot checks at some smaller banks in the last two months to probe possible misuse of capital linked to shareholders and transferring of ownership interests, said four people with direct knowledge of the matter.
The scrutiny comes amid concerns that some debt-heavy Chinese private enterprises have amassed substantial stakes in smaller banks without regulatory approval and are using the lenders for their personal borrowings.
"There may be many shareholders using small Chinese banks as ATM machines, but I don't think we have enough understanding of bank ownership to know," said Andrew Collier, managing director of Hong Kong-based Orient Capital Research.
"Certainly if there are under-capitalized corporates as majority shareholders of the less well-funded smaller banks you could have a bank run," he said, adding the regulators have so far done a good job of rescuing ailing financial firms.
Regulators have also asked banks to detail transactions with any related parties, which are entities controlled or jointly controlled by their major shareholders, between January 2018 and June 2019.
Another risk is that some big shareholders have pledged their shares as collateral for loans or other purposes such as acquisition capital or are investing in opaque wealth management products, said another lawyer who works with the CBIRC.
The pledging of shares can leave the bank at risk of a sudden shift in its ownership — potentially even a change of control — if the shareholder forfeits the shares in struggling to repay the loans.
The CBIRC didn't respond to Reuters' request for comment on its latest crackdown. The people spoke to Reuters on condition of anonymity due to the sensitivity of the matter.
Regulators' focus on small banks and their connections has intensified since late May, when the surprise takeover of Baoshang Bank sent shockwaves through China's interbank markets, sharply raising borrowing costs — not all of which have returned to their pre-takeover levels.
In their seizure of Baoshang, regulators cited improper and illegal use of significant bank funds by Tomorrow Holdings, which held 89% of the Inner Mongolia-based bank's shares.
"The rationale behind the checks arises from recent corporate activities. And such activities do not only exist in Baoshang Bank," said a Beijing-based lawyer, referring to shareholders' borrowing from banks.
A second bank was rescued last weekend with three state-controlled financial firms agreeing to inject funds into Bank of Jinzhou. The total amount to be invested was not announced, but they will take at least 17.3% in the troubled lender.
Shares in Bank of Jinzhou have not traded since April, when its auditor, EY, quit after refusing to sign off on its 2018 accounts because it could not agree with the bank on how to verify the actual use of loans made by the bank, some of which it feared did not match the purpose given.
The bank counts debt-laden Yinchuan Baota Refined Chemical Industry, a privately-run refining and petrochemical group, as one of its top three shareholders, according to its 2018 interim report. The chairman of Yinchuan's parent was arrested in December 2018 for alleged fraud.
Another example of the ties that build up between banks and their shareholders came last month with a fine of 200,000 yuan ($29,027.58) imposed on Bank of Liuzhou by the CBIRC for breaking limits on loans to a single group.
While rules limit banks to lending 15% of their net capital to a single entity, Bank of Liuzhou extended a 3.64-billion yuan credit line to its main shareholder, Liuzhou City Construction Investment Development Co, by end-2018, equivalent to 23.79% of the bank's net capital.
Large banks in China, as elsewhere, have shareholder registers that tend to read like as a fund manager who's who.
Not so for the smaller banks, whose registers often read more like a who's who of the corporate world and provincial government entities.
Chinese liquor giant Kweichow Moutai is the No.2 shareholder in Bank of Guizhou, which last month filed for a Hong Kong stock listing to raise up to $1 billion, with a 14.13% stake in the city commercial bank.
Moutai chairman Li Baofang said in May last year the group's financial arm had become "more and more important for the development of Moutai."
Chinese banks, like most of their global peers, don't report client-specific business details, but a review of Bank of Guizhou's IPO prospectus showed overall credit exposure to related parties as a percentage of its loan book soared to 44.3% at the end of March 31, 2019, up from just 6.8% in 2017 and bringing it close to the regulatory limit of 50%.
Several heavily-indebted Chinese conglomerates are also big bank shareholders.
China Evergrande, which has one of the highest debt ratios in the Chinese property sector, last month agreed to inject $1.9 billion into Hong Kong-listed Shengjing Bank, raising its stake to 25% from 17.3%, as the bank faced "a real need to raise its level of capital adequacy".
Shengjing Bank's loans to related parties jumped nearly six times at the end of last year, from 2017, even as its core capital adequacy ratio, which measures a bank's financial strength, dropped half a percentage point to 8.52% in the same period, its annual report showed.
Among other major bank stake owners, developer China Vanke is the largest shareholder with nearly 28% of the underlying shares in Huishang Bank, while a unit of the struggling HNA Group conglomerate owns 14.6% in unlisted Yingkou Coastal Bank.
None of the banks and companies responded to a request for comment from Reuters.
"The shareholding structure of some high-risk smaller banks might seem to be okay from the outside, but actually they're being hollowed out by transactions related to the shareholders," said a vice president of a city commercial bank.
"It's time to see through them with tighter regulations."