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China’s tightened rules on wealth management products having little effect

Suggestions a trial has now begun to bring unsecured Chinese WMPs, one of the main sources of shadow banking, onto banks’ balance sheets

PUBLISHED : Thursday, 17 November, 2016, 4:59pm
UPDATED : Thursday, 17 November, 2016, 10:40pm

China has made several moves this year to reduce the risks posed by opaque wealth management products (WMPs) – one of the main sources of income for the shadow banking industry.

However, as many companies, including those in distress, still view WMPs as a preferred form of financing, analysts say the measures as unlikely to have any great effect on their continued growth.

“The proposed regulations, in their current form, are positive but represent changes at the margins, and are unlikely to lead to a reduction in the scale of WMP issuance, as banks can find ways around the asset allocation restrictions,” according to a report from the Fitch Ratings.

“If implemented, they [the CBRC revised rules] only impose restrictions on the investment of proceeds from retail investors, which accounts for less than half of the total amount of the WMPs
Jack Yuan, analyst at Fitch Ratings in Shanghai

Earlier this year, the China Banking Regulatory Commission (CBRC) circulated revised rules which, amongst other things, prohibit proceeds from WMPs being sold to retail clients to be invested in shares or beneficiary rights.

It also requires banks to set aside reserves from net income until they have built up a capital buffer equivalent to 1 per cent of the value of their outstanding WMPs.

“If implemented, they only impose restrictions on the investment of proceeds from retail investors, which accounts for less than half of the total amount of the WMPs,” said Jack Yuan, analyst at Fitch Ratings in Shanghai.

“Banks can shift restricted assets to products held by institutional investors. The total amount of investment in shares or beneficiary rights is also quite moderate,” said Yuan.

Last month, the People’s Bank of China (PBOC) reportedly began a trial, to incorporate off-balance-sheet WMPs in its Macro Prudential Assessment (MPA) framework.

Under the MPA, the broad credit of individual institutions should not exceed the central bank’s M2 target growth by more than 20-25 per cent.

“That means the new methodology will only potentially affect the fastest-growing banks, especially mid to small-sized banks which have been quite aggressive in expanding WMPs, with little impact on big banks,” said Yuan.

Li Chao, the chief macro analyst at Huatai Securities, said: “The new rules are expected to only have an impact on newly issued WMPs, and outstanding WMPs are not included, therefore, it will not have any significant impact on the scale of WMPs.”

The new rules are expected to only have an impact on newly issued WMPs, and outstanding WMPs are not included, therefore, it will not have any significant impact on the scale of WMPs
Li Chao, chief macro analyst, Huatai Securities

Li’s view is echoed by China International Capital Corporation, which said in a recent report that “considering the fact that it is only imposing restrictions on new issuance, it will not reduce the total size of WMPs”.

So as the total scale is not expected to reduce significantly, the risk will not go away.

The outstanding balance of WMPs had reached 26.3 trillion yuan by the end of the first half of 2016, the equivalent to 37 per cent of GDP, from 16 per cent three years earlier, and around 77 per cent of outstanding WMPs resided off the balance sheet, according to the data from Fitch Ratings.

That means they are, in effect, bank contingent liabilities as there is a widely held expectation that issuing banks will stand behind their products, and it is exceedingly rare for banks to pass on losses to investors.

“An increase in provisioning requirements is positive, but would still be far below the capital levels and reserves banks would need to hold if credit was on-balance-sheet,” said the Fitch.

Fitch estimates that “impairment of just 2 per cent of outstanding products would be enough to wipe out all profits accumulated from WMP business over the life of the industry.”

It concluded that the regulators have not taken stringent enough measures to rein in WMP and other forms of shadow banking activity, because they represent too important an alternative source of credit for the real economy.

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