China Life, the country's largest insurer, is not the only firm facing a damaged reputation resulting from a lawsuit.

None of China's financial firms are immune to such a situation.

A lawsuit filed against China Life, which accuses the insurer of not adequately disclosing an audit report that uncovered accounting irregularities, has caught regulators' attention.

The China Banking Regulatory Commission (CBRC), the industry's watchdog, late last month announced a new line of regulatory revisions aimed at improving disclosure and transparency of domestic banks.

CBRC's focus this time, however, will be on the country's four largest state-run banks, two of which are preparing to issue shares in overseas markets.

China Construction Bank (CCB) and the Bank of China (BOC) will list shares, respectively, this year and in 2005.

"China's State-owned banks should learn a lesson from China Life," said Wu Nianzu, vice-chairman of the China International Finance Society.

"Banks need to make disclosures more adequately, on a regular basis, even before their IPOs (initial public offerings). Only by doing so can they attract more strategic investors from overseas."

CBRC hopes, by tightening banking regulations, it can boost investors' confidence and ensured the renewed popularity of Chinese IPOs, said Ba Shusong, a senior researcher with the State Council's Development and Research Center.

"Murky regulations and lack of transparency have long been concerns of overseas investors, when they are considering buying in Chinese shares," he said.

CBRC announced late last month on its website that it will increase "on-the-spot" supervision and pursue a "more complete coverage" of banks' businesses -- including loans and intermediary services.

On-the-spot supervision will ensure irregularities in banks' daily practices will be detected early, while the extension of supervision to intermediary businesses will guarantee the overall health of banks' assets, CBRC said.

Intermediary businesses have become a new source of growth for Chinese banks, as these services normally do not require as much capital as the traditional lending business, experts said.

The Industrial and Commercial Bank of China (ICBC), the country's largest lender, said last week it will see its revenues from intermediary businesses grow from 7 billion yuan (US$845 million) last year to 10 billion yuan (US$1.21 billion) this year.

Although banks will no longer have to worry about generating bad loans after they switch to intermediary businesses, losses will still be possible and some intermediary services could be riskier than issuing loans, Ba said.

"That is why regulations should be extended to all banking services," he said.

CBRC has also ruled commercial banks must report more regularly -- on a monthly basis rather than every three months -- on their non-performing loans (NPLs), which are considered the "Achilles heel" of the nation's banking industry.

China's Big Four, the largest four State-owned banks, have shouldered huge costs to reform State-run enterprises, most of which were unable to repay loans while being forced into bankruptcy, experts said.

CBRC requires all commercial lenders reduce their NPL ratios by at least 3 percent annually until the numbers are in line with international standards.

Although the Big Four have reduced their NPLs faster than planned, there has been skepticism that little has been done to prevent banks from creating new bad loans.

The average NPL ratio of the Big Four fell 5.85 percentage points last year, to 20.36 percent, as measured by internationally accepted standards.

"By ballooning total loans, banks will find it easier to reduce their NPL ratios temporarily.

But in the long run, the problem will worsen when the nation is on the downside of an economic cycle," Ba said.

ICBC said it will dispose of 300 billion yuan (US$36.1 billion) worth of NPLs within 3 years, and that it will slash the NPL ratio to less than 10 percent.

CCB, which has received the greenlight to list shares, said its bad loans totalled 193 billion yuan (US$23.4 billion), or just 9.25 percent of its total loans, at the end of last year.

BOC was second, with total bad loans of 344 billion yuan (US$41.5 billion), or about 16 percent.

The Chinese Government late last year injected US$45 billion of State funds into CCB and BOC to boost their capital bases.

But as the injections were in the form of transferring foreign exchange reserves into the banks' accounting books, it is unlikely the newly added capital will be used to write off the banks' bad assets, said Bruce Murray, a financial expert with the Asian Development Bank's Beijing Office.

CBRC has tightened regulations on the Big Four out of concern the injections will cultivate bad incentives.

The banks, economists suggest, could take it for granted there will be more bailouts if the situation worsens.

CBRC officials are urging the Big Four to improve their corporate governance, which is a critical step before they are accepted by overseas investors.

"The public listings will diversify the banks' ownership and gain overseas expertise in risk management. This will benefit the banks after China's banking market is fully opened," Ba said.

(China Business Weekly April 6, 2004)