Guaranteed repayment – the wild financial game no Chinese bank can afford to lose

China’s central bank is trying to smash the tacit rule of “guaranteed repayment” in the US$15 trillion asset management industry, but analysts say few financial institutions – especially banks – can afford to let their clients shoulder losses.

When a Chinese investor puts money into a trust fund or a wealth management product at a bank, the tacit understanding is that, whatever happens, the investor will get the principal back along with the promised return. This phenomenon – known as “absolute payment”, “guaranteed repayment” or “100 per cent bailout” – is unique to China.

It has also been a major factor behind the asset management boom, as more Chinese move money from saving accounts into the hands of asset managers. The amount of cash held in investment schemes in China reached 102 trillion yuan (US$15.35 trillion) at the end of last year. And the value of wealth management products at banks had expanded by more than 1,000 per cent to 29 trillion yuan by the end of 2016 – up from 2.8 trillion yuan at the end of 2010.

Regulators led by the People’s Bank of China have seen this tacit guarantee as an abnormality because it distorts the basic risk-return matching principle in finance. In a new draft regulation on asset management, the central bank said guaranteed repayment “severely distorts the essence of asset management products, undermines market discipline and worsens moral hazard”.

But for China’s banks, it is still a “who blinks first” game that no bank can afford to lose.