World’s biggest bank gets caught up in China investment scandal

PUBLISHED : Tuesday, 01 December, 2015, 5:39pm
UPDATED : Monday, 30 May, 2016, 5:09pm

Bad marketing and flawed investment products rocking the reputations of Chinese banks have now spread to the world’s biggest lender by assets.

Police in Sichuan province have detained five employees at an Industrial and Commercial Bank of China branch in Chengdu after wealth management products they marketed went bust, according to mainland Chinese media.

Officials at the Shenzhen-based fund management company that issued the products have also been arrested on charges of “illegally collecting deposits from the public”. More than 100 high-net-worth clients lost 400 million yuan in this latest instance of rogue banking in China.

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Default cases in China’s wealth management industry have become increasingly common, says David Cui, head of China equity strategy at Bank of America Merrill Lynch. “And it probably will become more common as growth continues to struggle and more and more businesses come under pressure financially.”

The wealth management industry in China has been driven by banks looking to dodge the rules for on-balance-sheet lending. Instead of taking in funds in the form of deposits, banks have promoted investment products that are channelled off their balance sheets to high-return but often risky projects such as real estate and mining.

The ICBC branch in Chengdu launched three products in 2012, promising annual returns of 18 per cent. More than 100 investors put in between 1 million yuan and 48 million yuan each for a total of 670 million yuan.

The funds were channelled to mining projects but those projects suffered a liquidity pinch last year and some 400 million yuan from two of the products was lost, Chinese newspaper Economic Observer reported.

Backing of a major bank such as ICBC has often been the selling point for investors. One person who invested 3 million yuan in one of the products told the Economic Observer that they would not have made the investment had it not been for the repeated assurances from ICBC managers.

On the contrary, the ICBC case showed bank managers ignored the risks and continued to market the products.

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Regulators have worked hard to remove bank guarantees from most of China’s wealth management industry – with some success. Growth in the industry has slowed as banks move funds back on to balance sheets to better account for risk.

At the end of June, assets funded by bank wealth management reached 7.4 trillion yuan, up from 6 per cent last year, according to data from Moody’s Investors Service. The rate of growth was far higher during the whole of last year, when that market nearly doubled in size.

But declining growth has not lessened the risk surrounding outstanding products, some of which are reaching maturity now. In many of the most recent default cases, bank managers sold products without receiving approval from headquarters, said Chen Shujin, an analyst at DBS Vickers in Hong Kong. They have not adequately informed clients on the risks associated with the products.

“Failure to give investors risk alerts is quite common around the country,” Chen said. “We’ve seen more and more such cases this year.

Reports on defaulting wealth management products surface in the Chinese media on average about once a week, she added. Still, only a fraction of the total wealth management market has run into trouble.

Struggling wealth management products have become so common that the cases are predictable, Cui pointed out. First, products are distributed without the knowledge of the bank’s headquarters. Then the funds are channelled to dubious projects, the products go bust and investors blame the banks.

After that, the cases disappear from mainland media. That’s because most of them are likely receiving state-brokered bailouts.

Despite the central government’s attempts to raise awareness of the risks associated with bank investment products, the reluctance to allow investors to lose money has stopped the true risks from being priced into the market.

“This type of guarantee cannot be maintained forever and when it’s broken, either because of government’s deliberate action or being forced upon by the market, the fallout can be difficult to handle,” Cui said.