Troubled shadow bank product tests no-default policy in China

If the investment fails to pay out, it could shatter assumption of implicit state-backed guarantees

PUBLISHED : Thursday, 16 January, 2014, 1:52pm
UPDATED : Friday, 17 January, 2014, 12:58am

A high-yielding investment product based on a loan to an indebted coal company is offering the latest test of Beijing's willingness to permit defaults in the mainland's shadow banking system.

If the product, which is scheduled to mature on January 31, fails to pay out as promised, it could shatter the widespread assumption that even risky investments carry implicit guarantees from the government and state-owned banks.

Economists say Beijing's zero-tolerance policy towards default has distorted capital allocation, as credit flows to the companies which are most able to call on a bailout if problems arise, rather than those that are most productive.

A situation … does not exist in which ICBC will assume the main responsibility [for the trust product]

Industrial and Commercial Bank of China, the world's largest bank by assets, said yesterday it would not assume the "main responsibility" for repaying investors in a troubled off-balance-sheet investment product that it helped to market.

ICBC's shares have fallen this week amid speculation it would be forced to help repay investors in a 3 billion yuan (HK$3.8 billion) investment product issued by China Credit Trust but marketed through an ICBC branch.

"Regarding this unsubstantiated rumour, a situation completely does not exist in which ICBC will assume the main responsibility [for the trust product]," an ICBC spokesman said.

That leaves unresolved the question of how or whether investors will be repaid.

Industry players said the bank was probably seeking a resolution.

"Right now China Credit Trust, the local government and ICBC are definitely at the state of intense negotiation, like a chess match," said a senior banker. "But with this kind of situation, you have to wait for things to cool down, then deal with it. Because if you pay off or don't pay off, there are problems either way."

Other market watchers are hoping for a default that could shatter what insiders call the "rigid repayment culture" surrounding trust products and other off-balance-sheet investments.

"The background of interest-rate liberalisation is that even financial institutions can go bust. So how can you go around rescuing a non-government trust product?" Qiu Guanhua, a bank analyst at Guotai Junan Securities in Shanghai, told clients in a conference call yesterday.

While shadow banking products typically do not carry a formal guarantee from the banks that help to create and sell them, bankers worry they may face pressure to shield investors from losses in order to protect their reputations.