China Should Allow Wealth Product Defaults, Deutsche Bank Says

China Should Allow Wealth Product Defaults, Deutsche Bank Says

China should allow defaults of some wealth-management and trust products to reduce incentives for financial institutions to sell risky products and maintain stability in the financial system, Deutsche Bank AG (DBK) said.The comments by Ma Jun, Deutsche Bank’s chief China economist, were in a report citing a troubled trust product sold by China Credit Trust Co. Industrial & Commercial Bank of China Ltd. last week rejected calls to bail out the 3 billion-yuan ($496 million) product it distributed for China Credit, a bank official with knowledge of the matter said. China Credit raised funds for a coal miner that subsequently collapsed.

“We believe that its spillover effect will be very limited but its long-term implication is very positive, as permitting some wealth-product management defaults is an important step towards reducing systemic risks,” Ma wrote in a note to clients today. Ma is top-ranked for China economics by Institutional Investor magazine, according to Deutsche Bank.

The State Council has tightened controls on so-called shadow banking with rules targeting off-the-book loans to clamp down on hidden lending. Shadow banking includes activities ranging from trusts and private lending between individuals to banks’ off-balance-sheet savings vehicles, known as wealth-management products.

Aggregate financing, the broadest measure of new credit, fell to 1.23 trillion yuan in December from 1.63 trillion yuan a year earlier, central bank figures show.

‘Blow Up’

WMP “defaults will significantly enhance the ability of the market to price risks, reduce the incentive for financial institutions to sell risky products, and contain the ability of risky issuers to borrow excessively from the market,” Ma wrote.

Lu Ting, Bank of America Corp.’s China economist , said the trust industry needs a “blow up” to improve market price risks. Lu said he sees a “last-minute deal” on the trust loan from China Credit Trust with the company, ICBC, local governments and investors sharing the cost.

“Even if those stakeholders can manage to avoid defaults of this CCT trust loan, we believe some trust loans, especially some mining trust loans, will default sooner or later,” Lu wrote in a note today.

In case of a default, the impact won’t be huge, said Yang Feng, a bond analyst at Citic Securities Co., China’s largest brokerage by market value. “It’s not like a default on the bond market. I still don’t believe there will be any defaults on the bond market this year. The cost will be too high for local governments.”

Risks, Returns

China’s regulators can’t tolerate massive defaults in trust products or WMPs in the near term due to severe consequences such as a widening in credit spreads and rising bond yields, BNP Paribas SA analyst Judy Zhang wrote in a report dated Jan. 17.

“It is only after the central government sorts out a fair distribution of tax income and investment responsibilities with local governments, before every project is decided by risks and returns, can default be allowed to happen,” said Xu Gao, chief economist at Everbright Securities Co. “By then, the yield will reflect potential returns, not implicit government guarantees.”

To contact Bloomberg News staff for this story: Allen Wan in Shanghai at awan3@bloomberg.net