China Tightens Regulations on Wealth Management

Updated March 27, 2013, 11:08 a.m. ET

China Tightens Regulations on Wealth Management


‘Shadow banking’ in China was worth $3.7 trillion in 2012 according to Standard & Poor’s estimates. Qiang Liao of the S&P tells the WSJ’s Jake Lee why these risky investments are being sold across the country.

BEIJING—China moved to rein in wildly popular but opaque investment products that form a key plank of the nation’s shadow-banking system, after the high-profile failure of one product offered a glimpse of the risk they pose to the financial system.

The rules issued Wednesday by China’s banking regulator came as China’s four biggest state-run banks said they had more than 3 trillion yuan ($467 billion) worth of such products outstanding at the end of last year, their fullest disclosure yet of their exposure to the products and a move signaling their own caution toward their proliferation.

They are called wealth-management products, which some Chinese regulators have said are sold with limited oversight or disclosure of what they contain. They are typically short-term investments that banks market as a high-yield alternative to bank deposit rates, which are kept low by the government. About half are invested in low-risk assets such as government and corporate bonds and money-market products, according to research firm Cnbenefit. But many others are backed by everything from loans to developers to accounts receivable to valuables such as gold and jewels.

Issuance has expanded rapidly in recent years. Fitch Ratings estimates the total amount of outstanding wealth-management products was around 13 trillion yuan at the end of last year—equal to about 14.5% of total banking-system deposits—compared with 8.5 trillion yuan at the end of 2011.

Analysts worry that some of the money going into these products has been used to make high-interest loans to risky private businesses shunned by the banks themselves, a phenomenon critics say could exaggerate loan and investment losses in China’s financial system if an economic slowdown led to widespread defaults.

“In the process of developing this business, some banks have dodged lending restrictions and not promptly isolated investment risk,” the regulator said in a statement outlining the new rules.

The China Banking Regulatory Commission said on Wednesday that banks must clearly link wealth-management products with specific assets. The notice also said that banks must disclose who will ultimately use the funds and for what purpose, and that each product must be audited.

Its statement also said that outside of the formal bond market, no more than 35% of a bank’s total issued wealth-management products should be invested in debt or used to make loans.

At a news conference Wednesday, Industrial & Commercial Bank of China Ltd.601398.SH -1.94% President Yang Kaisheng said that the portion of his bank’s outstanding wealth-management products invested in such a way might be slightly in excess of the CBRC’s requirements.

The move comes after the collapse of a product marketed by an employee of a branch at Huaxia Bank Co. 600015.SH -7.02% —China’s 13th largest bank by assets—resulted in December street protests by investors in Shanghai’s central business district.

Huaxia declined to repay the investors, saying that the branch had only marketed the product and that it was created by a third-party investment company. The investors were later repaid their principal by a company that had promised to guarantee the product’s repayments.

Some regulators have zeroed in on how banks manage them. Banks typically pool funds raised by wealth-management products and invest the money in poorly disclosed assets or projects, leading to a lack of clarity about the underlying assets.

That allows banks to use short-term funds raised from the sale of products to buy the longer-term assets that have the higher yield banks need to give investors the promised return. With most of the funds tied up in long-term assets, that could leave the banks short of cash if investors stop buying new products.

China’s major banks have already grown more conservative in how they issue wealth-management products.

At the end of 2012, Bank of China Ltd.’s outstanding wealth-management products were lower than a year earlier, down 12%. The amount China Construction BankCorp. 601939.SH -2.78% had outstanding rose 27% last year. However, the volume of products that it keeps off-balance-sheet—where the bank technically isn’t responsible to cover any losses—fell.

Still, even as the major banks play it safe, smaller banks are churning out products in ever greater numbers.

According to data from CitigroupC -0.83% China’s city and rural commercial banks accounted for 43% of the wealth-management products issued in January, up from 33% issued a year earlier. In January, the big-four banks—Bank of China, Industrial & Commercial Bank of China Ltd., China Construction Bank., and Agricultural Bank of China Ltd. 601288.SH -4.96% —were responsible for only 28% of product issuance, down from 32% a year earlier.

The report also said that the smaller banks were offering returns significantly higher than the major banks, “which may reflect the small banks’ more risky asset-allocation strategies for higher yields” to compete for sales of wealth-management products.

Ye Linfeng, a researcher with Cnbenefit, said that China’s smaller banks, which typically started issuing wealth-management products later than the major banks, are trying to bolster their fee income out of concern that the central bank’s efforts to liberalize interest rates will increasingly eat into the fixed margin between deposit and lending rates they have traditionally relied on to turn a profit.

“China’s city and rural commercial banks don’t have the scale of major banks and so need to offer higher returns to be able to pull customers away from their bigger competitors,” Mr. Ye said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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