China economy

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

The central bank wants to put a stop to the unspoken promise of 100 per cent bailouts in the wealth management industry but no one wants to be the first to blink

PUBLISHED : Wednesday, 22 November, 2017, 10:42am
UPDATED : Wednesday, 22 November, 2017, 9:15pm

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.

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If investors fail to get a return from a wealth management product sold by a bank, the institution’s reputation could be damaged and it may lose clients to rivals, according to Deng Haiqing, an analyst with JZ Securities.

“Wealth management products sold via bank outlets are seen as another form of bank deposit … for both the general public and the banks themselves,” Deng wrote in a note.

While a few banks have tried to ask investors to shoulder losses, their efforts have generally ended in protests or dispute.

In 2012, when 91 investors in a wealth management product sold by a Shanghai branch of Huaxia Bank knew their investments were at risk, they protested at the branch until they were bailed out by the product’s guarantor.

Two years later, investors in a 3 billion yuan China Credit Trust product sold by the Shanxi branch of Industrial and Commercial Bank of China were paid out even after the coal miner at the heart of the scheme declared bankruptcy.

Amanda Yu, 38, is one of the high-net worth “qualified investors” that Chinese banks do not want to lose. She is looking at a five-year private scheme with a minimum investment of 5,000,000 yuan recommended by her bank. The scheme promises an annual return of 10-15 per cent, or about 10 times the one-year bank deposit rate, for equity investment in artificial intelligence and robot start-ups.

“In the written contract, there’s no guarantee of the principal or promised returns,” Yu said. “But my bank manager has made repeated verbal promises that the principal would be absolutely safe. I guess it will be the case even after the new regulation comes in.”

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China Orient Asset Management chief economist Wu Qing said Chinese investors were used to “risk-free” and guaranteed repayment products. “If the guarantee is removed, it will be much more difficult to sell wealth management products,” he said.

Wu said new financial products, such as credit default swaps, should be developed to help spread risk. “Banks can attach an insurance scheme or even valuation adjustment mechanism for clients,” he said.

Wu Qi, a senior researcher at the Pangoal Institution, said guaranteed payments were an outgrowth of China’s changing financial landscape, where digital technology meant investors could shift money from one bank to another with a few clicks or swipes on their mobile phones. As a result, banks had to woo clients with promises of high returns and safety, he said.

The central bank’s new regulation, which was published on Friday for public feedback, was based on “good intentions” but might not address the issue effectively, Wu said.

“It remains a question whether banks will really implement it. In the past, they tended to bypass government regulations through a ‘drawer agreement’,” he said, referring to a secret deal to avoid regulations.

Standard Chartered Bank chief China economist Ding Shuang said guaranteed payments were largely beyond the scope of regulators.

“Guaranteed repayment is not a matter that financial regulators have a full control of,” he said.

One of the main issues is the requirement that “any institution or any person” report guaranteed repayments to the central bank or the financial regulators.

As online commenters suggest, banks would be unlikely to turn themselves in for repaying clients and investors would be unwilling to punish the banks for giving them their money back in full.

Additional reporting by Jane Cai