OREANDA-NEWS. Fitch Ratings says a corruption investigation at China Grain Reserves Corporation (Sinograin) will not have negative impact on Agricultural Development Bank of China's (ADBC; A+/Stable) ratings, but it has highlighted weaknesses in the bank's underwriting practices.

The investigation focuses on embezzlement of public funds at certain Sinograin branches through the procurement of substandard rice. ADBC does not disclose details of its loan book, but given its role in the sector, Fitch believes ADBC could have substantial exposure to Sinograin, a state-owned grain procurement company tasked with managing and operating the central grain and oil reserve. Grain, oil and cotton procurement loans form over 45% of ADBC's loans and grain procurement represents a major part of this business.

The allegations of corruption, if proven true, are likely to have negative implications for ADBC's asset quality. While the current allegations concern third-party grain depots under contract in north-eastern China, they underscore wider vulnerabilities with the use of contract depots, in particular, and the state grain stockpile scheme, in general.

ADBC's policy-driven lending carries de-facto government guarantees, but these guarantees are mainly intended to counter volatility in agricultural product prices. It remains unclear how the government guarantees will be enforced if there is fraudulent behavior. ADBC shares the responsibility of supervising grain procurement transactions due its role as the provider of financing. The allegations point to inconsistent application of underwriting standards regarding the quality of underlying commodities. With partial culpability, ADBC is more likely to shoulder losses if Sinograin's credit profile is weakened.

That said, ADBC's Issuer Default Rating (IDR) is driven by the bank's quasi-sovereign status, given its 100% state ownership. There is no indication the Sinograin corruption investigation will diminish ADBC's policy role or the state's willingness to support it. Local media have reported that the Ministry of Finance is seeking to inject CNY150bn (USD24bn) into ADBC in the form of tax refunds as part of measures to reform the policy banks. The government is also seeking to better define and further emphasise the policy-driven functions of ADBC.

Domestic bond issuance will remain ADBC's biggest funding source, with expectations of sovereign backing firmly in place. In April 2015, the People's Bank of China lowered the reserve requirement ratio (RRR) by 1% for all banks, but ADBC received an additional 2% reduction. This followed a previous round of monetary loosening in February 2015, during which ADBC received an additional 4% reduction over a general reduction of 0.5%. The latest cut decreased ADBC's RRR to 10.5%, compared with 18.5% for banks in general.

ADBC's IDR will remain sensitive to a weakening in its policy role. Fitch believes ADBC's role in procurement lending is unlikely to be replaced by commercial banks given the profitability of this business is low. As such, Fitch does not expect any change in the state's propensity to support ADBC.