Chinese wealth management products threaten banks' liquidity, in blow to Beijing
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Chinese wealth management products threaten banks' liquidity, in blow to Beijing

The increasing popularity of wealth management products in China has the potential to reduce banks' deposits and destabilize the banking system more generally, says CreditSights.

The legitimacy of Communist Party of China rule relies on strong economic growth and the current strength of state-owned banks and enterprises. But the rise in popularity of wealth management products since 2011 has put pressure on the banking system in China, threatening Beijing's economic control and political leverage, says Matthew Phan, research analyst at CreditSights based in Singapore.

 Source: Reuters

“This [the rise of wealth management products] is... highly political, because banks are the centrepiece of China’s financial system, and the state ownership of the big banks gives the state a big policy tool in the form of being able to direct banks to lend to this or that sector,” Phan says.  “If the banks start to lose deposit liquidity, then they will be less able to serve this function. So the intense competition from wealth management products leading to a slowing or negative deposit growth means a gradual erosion of the bank’s financial strength.” 

In the short run, the push for wealth management products – propelled by the excess net interest margin banks have historically accumulated given the depressed policy rate – threatens to reduce banks’ liquidity pools. This comes at a time when their collateral is under pressure, thanks to softening property prices. 

In 2011 as the eurozone debt crisis took hold, Chinese banks felt the pinch. Liquidity was tight and the interbank lending rate (Shibor) was high. It was around this time that wealth management products grew in popularity. Through these bank-offered products, investors could get relatively high yields on their investments while escaping low interest rates on bank deposits.

According to CN Benefit, a wealth management consultancy based in Chengdu, sales of wealth management products totalled Rmb12.14 trillion ($1.9 trillion) in the first half of 2012. This was up by 43% on the same period last year.

This comes at a time when China is preparing itself for a once-in-a-decade leadership change.

“We think this is one reason why the PBOC [central bank] took action to increase deposit rate flexibility – to give banks the ability to compete for deposits and retain deposits in the system,” says Phan.

Although in the short term a liberalization of rates will mean a drop in banks’ profitability as well as their ability to deal with bad assets, in the long term, this could be a step towards reforming China’s financial markets. But Beijing has shied away from nurturing a structurally higher interest rate regime for fear of triggering indebtedness and losing capital control. Nevertheless, market forces – such as the migration of capital away from bank deposits to higher-interest-bearing wealth management products – could trigger higher lending rates.

Lessons learnt?

Beijing highlighted the power of state-owned banks in 2008 when the financial crisis struck. China’s central bank pumped over Rmb4 trillion into the economy to make credit easily available in an effort to shield China from the crisis.

But a cycle of fiscal tightening quickly followed when lending got out of hand. As a result, individuals and companies desperate for capital sought alternative methods to raise extra cash and informal lending networks grew at an unprecedented rate. But with a slump in the property market and with international demand for Chinese exports diminishing under the weight of the eurozone debt crisis, businesses found paying back these largely unregulated loans out of reach. 

But regulators in China do have the ability to bring wealth management products under control, says Phan. “Banks are the largest distributors of these wealth management products, so by working with the banks, the regulators should be able to get a sense of how much is being issued or outstanding,” he says. “This is very unlike the decentralized, informal credit sector with probably thousands of unofficial lenders and it would probably be very hard to get a comprehensive data set.”

Indeed, the China Banking Regulatory Commission (CBRC) has already taken some steps to regulate the sector. Now there are some wealth management products kept on bank’s balance sheet. But there is still some way to go.

The Bank of China (BOC)holds a larger proportion of wealth management products on its balance sheet as structured deposits,” says Phan. “The Industrial and Commercial Bank of China (ICBC), on the other hand, has stated that over 80% of its wealth management products are off sheet.”

So although the regulators are working on it, there is no real standardized way of differentiating between wealth management products, and there is no concrete data on how big the market is.

Nevertheless, the rise in popularity in wealth management products might also have some positive side effects.

“It must be noted that, ironically, while competing for deposits, the wealth management market has potential for banks’ profitability in the future,” says Phan. “Banks are already earning significant fee income from selling wealth management products, and this segment is growing rapidly.”

What’s more, in the long term, Chinese banks need to diversify away from interest-derived income to fee-generating products, and cater to the growing pool of high-income consumers, buoyed up by the country’s high savings rate and changing demographics.

Higher deposit and lending rates are ultimately necessary to rebalance China’s economy towards a domestic consumption model, but fears are growing over the short-term economic and political consequences of any shift in this direction.

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