China Corruption Bank

EVEN in a country where thousands of public officials and private businessmen abscond with millions of dollars each year, it is not every day that the head of the third-largest bank is turfed out for graft. The removal of Zhang Enzhao as chairman of China Construction Bank (CCB), allegedly for taking bribes either in exchange for approving soft loans or for manipulating purchases of computer equipment, was reported in the Hong Kong press on March 15th. The bank has confirmed Mr Zhang's resignation, and has appointed Guo Shuqing, a central-bank official, as its new party chief—a job that tends to go with the chairmanship.

Mr Zhang's fall comes at a bad time for China's state banks. CCB already faces four other embezzlement cases, all uncovered since September. More than 50 staff are accused of stealing a total of over 700m yuan ($85m). Mr Zhang's predecessor, Wang Xuebing, was sentenced to 12 years in prison in 2003 for misdeeds when he was a junior official at the Bank of China (BoC). That bank, meanwhile, is investigating a fraud at its office in the northern city of Harbin. Mr Zhang's seniority and CCB's position as the leading reformer among the state's big four lenders mean that corruption can no longer be written off as a minor problem in a few rural branches.

The government contends that graft is not increasing: it is merely that more is coming to light as the industry is restructured. Paul Coughlin of Standard & Poor's concurs: “As the banks improve internal audits and centralise management, they will uncover more fraud.” That Mr Zhang has been publicly called to account, rather than quietly shuffled to another top job, as might have happened a few years ago, looks like a step forward. And the China Banking Regulatory Commission (CBRC) has become much stricter. In February, it exhorted the banks to tighten risk controls and guard against “irregular activities”. According to a source close to the CBRC, the regulator acted with alacrity this time—placing Mr Zhang under house arrest on March 11th, initially on suspicion of only minor transgressions—because it was tipped off by its American counterparts.

However, all this activity merely reveals the scale of the task of cleaning up China's banks. Mr Guo, then at the central bank, told the official media this month that CCB had disciplined 40,000 employees and BoC at least 18,000 for misappropriating funds and making unauthorised loans. Signs of widespread corruption are likely to set back the next stage in the banks' ambitious reform plans. The government plans to list three banks on the Hong Kong, Shanghai or possibly New York stockmarkets this year. Bank of Communications (BoCom), the fifth-biggest, is set to raise $2 billion, followed by a $5 billion-10 billion flotation of CCB and a $4 billion-5 billion offer from BoC.

But investors, particularly foreigners, may now demand a delay, a lower price or both. Mr Zhang's case “has an enormous impact,” says one senior banker in China. “How do you convince foreign investors that this is a one-off?” People close to CCB were adamant that its listing would go ahead this year, perhaps at a lower price, if Mr Zhang was replaced quickly. “There is no blind panic. Better now than in three months,” says one observer, who adds that Wen Jiabao, the prime minister, recently urged that bank reform should be accelerated, despite the scandals.

Others, however, are more cautious. Zhu Min, head of restructuring and listing at BoC, told The Economist last year that as far as the timing of a flotation was concerned: “The first issue is whether we are ready; the second issue is whether we are ready; the third issue is whether we are ready.” It is significant that, despite courting by the Chinese, no big international bank has yet bought a stake in CCB or BoC, though HSBC owns 19.9% of BoCom.

Much therefore hangs on the next few months. The government has an incentive to rush the banks to market—partly to maintain the momentum of reform but largely to outpace an economic slowdown. Even a soft landing is expected to produce a new wave of non-performing loans that could make the banks look less attractive to investors.

But such haste carries big risks. Because the banks' flotations would be the country's most prominent and ambitious yet, any corruption unearthed once they are public would damage investor confidence badly—not just in the banks, but in other Chinese companies too. That could bring investors' enthusiasm for China to a swift and premature end.