While this seems like a somewhat distant memory to the general populace almost a decade later, there are now similar situations occurring in other areas of the world. China’s economy, the second largest in the world, is at risk of a similar financial collapse due to an increasing amount of fraudulent collateral. These lax lending practices, despite initial checks, are getting banks into a world of trouble.

If you were looking into buying a house in 2008, you likely experienced quite a shock when there was a giant collapse in the value of housing. This dramatic change in real estate prices happened all over the country. This change spurred forward high leverage lending and subprime mortgages, helping to contribute to the global financial crisis.

Verification to Disappearance

China CITIC, a bank with an operating branch in Shanghai, was a victim of this current ghost collateral issue. Acting on behalf of the bank, lawyer Wang Chaoyu was supposed to perform checks on the collateral being offered for certain loans. One of the loans was worth almost $3 million dollars. In this case, the client was using a certain amount of steel that he kept in a warehouse on the outskirts of the city.

Mr. Chaoyu did his duty and verified that the steel was in fact present. By doing so, the bank granted the client a loan. The client, Shanghai Hanning Iron and Steel Co Ltd., failed to meet a certain amount of payments, and in accordance with the terms and conditions of CITIC, they became the rightful owners of the steel collateral. However, when they went to retrieve their collateral, it was nowhere to be found. CITIC is in court attempting to regain their losses.

Different Ways to Get Fraudulent Collateral

CITIC’s case of fraudulent collateral is just one way out of many that people have been pushing this through the Chinese banking system. It’s a good example of the fact that many banks are doing the appropriate spot checks, with unfortunate follow up results. Here are a few examples of other ways that people are misusing the system.

  • Bribes
    • Kickbacks seem to be relevant in this fraudulent system. Clients often pay loan officers or bankers themselves to turn a blind eye. People try to get past the problematic aspect of the collateral in order to push it through to approval.
  • Multiple Lenders
    • Some of the clients have taken to using the same collateral for multiple lenders. The documentation is likely legal, but if they default, the collateral will end up as first come first serve.
  • Fake Documentation
    • Borrowers will use fake land or warehouse receipts as documentation to prove the location, state and existence of their collateral.
  • Pre-sale
    • As the client stresses more financially, they may sell their collateral early. This helps them financially but leaves them in a bad spot when they finally default on their payments.

Mainland China is facing its slowest growth in over a quarter of a century. This is making it harder for borrowers to make their payments on time, meaning that there are more defaults. However, this fraudulent collateral is only exacerbating the problem. It is increasing the debts for China’s banks, making financial crisis more likely. Until Chinese banks can develop a more secure lending system and get this ghost collateral under control, China may be facing a financial crisis similar to that of 2008.

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