Fraudulent loans are on the rise in China as economic growth slows, threatening to further undermine the country's $29tn banking system, which is already under pressure from an indebted corporate sector.

A series of loan frauds has ripped holes in the balance sheets of a range of lenders, from the large — Agricultural Bank of China — through to the phalanx of small commercial lenders.

The latest victim to emerge is Bank of Liuzhou where $4.9bn (Rmb32.8bn) in fraudulent loans were discovered by the bank late last year, according to the state-backed China Business Journal. That represents more than 40 per cent of the bank's total assets of Rmb80bn at the end of 2014 — a dent so large on the bank's balance sheet that it is likely to require government intervention.

"I guess local government may have to swap the bad loans with asset injections to address the solvency issue," said Liao Qiang, director of financial institutions ratings at Standard & Poor's in Beijing.

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Fraud, which often takes the form of forging collateral, is also a result of corruption, where local government enterprises bribe small banks to grant them huge loans. Cases such as these have left banks and investors nursing big losses. Poor internal controls make the fraud harder to catch early.

In the case of Liuzhou, a new chairman at the bank in 2014 discovered the massive pile of debt accrued by one borrower during the tenure of the previous bank head.

Upon that revelation, the borrower, a businessman, allegedly ordered the murder of the chairman, China Business Journal reported.

An investigation by the bank reportedly showed that the businessman and certain relatives had forged collateral and proof of business operations to borrow $4.9bn. Local media in China said that up to Rmb7.9bn — more than eight times the bank's 2014 profits — in fraudulent loans was expected to be unrecoverable. The businessman could not be reached for comment.

The case is one the country's biggest banking frauds in decades.

This followed China Citic Bank, the country's ninth-largest bank by assets which late last month said it was investigating a $147m fraud.

In that case a bill financing agent misused a banker acceptance — a sort of IOU — to obtain cash which he then ploughed into China's then-booming stock market.

Just a week earlier, the mainland's third-largest bank, Agricultural Bank of China, was swept up in an embezzlement case involving $578m.

Corruption at city commercial banks in China has added to the overall risk in the country's banking system, says Wang Chunyang, a professor at Peking University's HSBC Business School, who has studied the tier of lenders.

Formed in the mid-1990s by consolidating thousands of rural credit co-operatives, city-level banks were mandated to lend to small and medium-sized businesses, the traditional engine of growth in emerging economies.

But Mr Wang's research shows that far from helping smaller borrowers, the commercial bankers have taken bribes from large government-run enterprises in return for massive loans. That has left them with loan books geared towards slow-growing government enterprises and big single borrowers.

"In the future, the city commercial banks will find themselves in a very dangerous situation," Mr Wang said. "I think some of them will not be able to cover their losses."

Total assets at city commercial banks accounted for about 12 per cent of China's total banking system at the end of last year, compared with 38 per cent for national-level commercial banks, according to data from China's banking regulator.

Lending growth at the city banks outpaced every other tier of the banking system in 2015, growing by 25 per cent year on year in December. Liabilities at the national commercial banks grew by just 9 per cent during the same period.

Bank of Liuzhou could not be reached for comment. It has not posted on its website information regarding the case and it was unclear when it would post annual results for 2015.

http://www.cnbc.com/2016/02/17/chinese-bank-hit-by-loan-fraud.html