Here’s All About The Chinese Fake Gold Scam And Its Impact On China

China is now at the centre of one of the worst gold scams in recent times, with at least 4 per cent of its gold reserves being suspected to be fake.

In addition, the scam has put pressure on its ‘shadow banking’ and insurance industries.

The scam came to light after Beijing-based website Caixin Media broke the news of fake gold offered as collateral by Chinese gold processing company Kingold for 14 billion yuan (Rs 14,850 crore approximately) for availing of loans.

Kingold, a private processor headquartered in Hubei province, is a company listed on Nasdaq with Peoples Liberation Army (PLA) veteran Jia Zhihong as its chairman.

24-Carat Gold Jewellery Company

The 18-year-old gold company claims to produce 24-carat jewellery in China and supplies to wholesale and retailers in the Communist-ruled nation.

The company claims on its Website that its sales have grown from $29 million in 2006 to $1.4 billion in 2016.

Earlier, Kingold was a gold factory in Hubei affiliated with the People's Bank of China that was split during the restructuring of the bank.

Kingold had availed of loans from lenders such as China Minsheng Trust, Hengfeng Bank, Dongguan Trust and Bank of Zhangjiakou, all part of the Chinese ‘shadow banking’ system, an alternative source of funding for financially weak firms.

The gold firm is supposed to have taken loans for cash support, expanding its gold reserves and other businesses.

In order to secure loans from lenders, Kingold offered 83 tonnes of gold bars as collateral. When the Hubei-based firm defaulted, the lenders tried to encash the gold offered as collateral only to find them to be ‘gilded copper’.

Kingold had availed of loans from lenders such as China Minsheng Trust, Hengfeng Bank, Dongguan Trust and Bank of Zhangjiakou, all part of the Chinese shadow banking system, an alternative source of funding for financially weak firms.

How The Fraud Came To Light

The fraud came to light in February this year when Dongguan Trust found the gold pledged as collateral to be fake after Kingold had defaulted since late last year.

An alert China Mingsheng Trust Co. Ltd, which lent 600 million yuan as late as May last year, then got a court order to test the gold bars pledged with it as collateral as the gold company’s interest payments were due.

Results of the test of the gold bars showed that they were, in fact, copper alloy, leading to an investigation by the authorities into the whole episode.

The 83 tonnes of gold make up near 22 per cent of China’s annual gold production and 4 per cent of the country’s reserve, leading to suspicion on the quantity of fake gold in circulation in that country.

Kingold has totally acquired loans to the tune of 30 billion yuan (Rs 31,820 crore) since 2015 from over a dozen trusts that are part of the Chinese shadow banking system.

The trust had covered their liabilities either through insurance or taking gold as collateral.

The gold scam now raises doubt over how the lenders of the remaining 16 billion yuan (Rs 16,970 crore) would recover their dues.

Problems For Chinese Insurance Firms

Chinese government insurance firm PICC Property and Casualty Co Ltd (PICCPC) and a couple of other small insurance companies had covered for these loans that Kingold availed of.

Their roles come into question particularly when Jia Zhihong, Kingold Chairman, has denied that his company had offered fake gold as collateral.

When the Chinese media company contacted him, he wondered: “How can it be fake if insurance companies agreed to cover the loans?”

He refused to comment further.

Media reports point to two reasons that have landed Kingold in the current mess.

How Kingold Landed Up In A Mess

One, when China began to build cities to help people shift to them and millions of houses were constructed. Kingold, in order to take advantage of the expecting housing demand, invested billions of yuan in constructing houses.

But financial problems and slow growth resulted in lower demand for houses, resulting in real estate prices crashing. This led to Kingold defaulting on its payments.

Two, the gold company bid for a controlling stake in government-owned auto-parts firm Tri-Ring in 2018. Kingold came up with an offer of seven billion yuan (Rs 7,400 crore) in cash to take almost the entire stakes in the company.

Kingold eyed the auto parts company as it owned land blocks in Wuhan and Shenzhen that are worth nearly 40 billion yuan.

But the controlling stakes came at a heavy price as a major part of Tri-Ring's assets got frozen amid the investigations and subsequent debt disputes.

Controversy Over Buying Tri-Ring Stakes

The takeover courted a controversy as Kingold had borrowed 16 times higher in 2016 than what it had borrowed the previous year.

This resulted in its debt-to-asset ratio nearly doubling to 87.5 per cent. The loans were obtained by pledging nearly 55 tonnes of gold.

Rival bidders protested against this loan arrangement and the transparency of the process was questioned. This was because the gold company had only assets to the tune of 2 million yuan in 2017 and this created doubts if it could manage the deal.

However, the gold firm initially paid 2.8 billion yuan as the first instalment soon after winning the bid and by December 2018, the takeover was completed. Tri-Ring’s problems continued, though, putting stress on Kingold.

Lenders Seek Legal Action

Finding fake gold in their possession as collateral, the lenders have gone to the court demanding that PICCPC cover their losses. But the insurance firm says that it is Kingold that should initiate the procedure and not the shadow banking firms.

The lenders allege that it was the insurance firms involvement that helped Kingold to sign the gold-backed loan deals.

Insurance policies provided by PICCPC was a major factor in allaying their fears over providing such huge loans to the jewellery company.

But for the insurance firms chipping in, the lenders would have conducted a random sample of the gold bars offered as collateral.

This could have helped them avoid the current problems they are facing.

China’s Shadow Banking System Faces Crises

The Chinese Trust or shadow banking industry is worth $3 trillion (Rs 225 lakh crore). It is currently facing several such defaults that have rocked the country’s entire financial system.

Loans worth $766 billion (Rs 57.22 lakh crore) are due this year, but it is feared that there could be hundreds of defaults.

Kingold is one of the defaulters, but the damage has been complicated by the fake gold offered as collateral.

This could now impact the banking system itself and the credibility of the Chinese financial system is now being questioned.

With China facing a slew of problems arising from the novel Coronavirus pandemic and other issues such as border dispute and Hong Kong unrest, the gold scam has come at a wrong time.

The scam has brought memories of a similar scam in 2016 when gold bars offered as collateral to 19 Chinese lenders were found to be adulterated.

When one of the lenders melted the gold bars, tungsten plate was found amidst them.

Who Is Jia Zhihong, Kingold Chairman?

The scam has brought to focus Kingold’s 59-year-old Chairman Jia, who has served in the rear supply service department of the PLA in Guangzhou and Wuhan. He was responsible for managing gold mines owned by the Army.

Jia has also founded Wuhan Kingold Jewelry Co Ltd, a subsidiary of Kingold Jewelry. He is also on the board of Tri-Ring Group Corp and Vice-President of Gems and Jewellery Trade Association of China.

He was instrumental in getting the loans from the trusts, promising them that in return, he would help them get rid of their problems bad loans.

Jia has also been smart in getting loans from agencies that are outside of Hubei province with Mingshen Trust coming off as the worst hit.

For now, Dongguan Trust has filed a case with the police. It is demanding 1.3 billion yuan (Rs 1,380 crore) from PICCPC against a default of 1.8 billion yuan (Rs 1,900 crore) by Kingold.

The only positive action against the gold company, so far, is the Shanghai Gold Exchange disqualifying Kingold as a member from 24 June.

More Woes For China

An Indian investor in Kingold living in the US has now gone to a New York court for violating securities laws. The suit was filed after the gold firm's shares nosedived on Nasdaq.

This further makes things hard for Chinese firms to list in the US stock market. On 21 May this year, the US Senate passed a Bill to delist Chinese firms from exchanges as they are not following the standards for US audits and regulations.

China has refused US audits of some of these companies as they are government-owned.