Chinese Move to Wealth Products May Undermine Bank Stability

Lin Baozhen, a 61-year-old retired accountant in Shanghai, is a dream customer for Chinese banks. For a decade, she has kept her money at China Construction Bank Corp. (601939) in an account currently paying 3.5 percent interest.

Not anymore. This month, Lin moved half her 800,000 yuan ($127,000) savings into a 95-day investment product offered by the bank that guarantees the principal and pays 5.5 percent annualized returns -- 1 percentage point higher than the inflation rate. Like other Chinese moving deposits to higher- yield investments in record numbers, Lin plans to shop around for the best rates for the rest.

“I am not investment-savvy, but it would be stupid of me if I just leave the deposits there doing nothing,” Lin, clad in a black down coat, said in the lobby of her bank branch in Pudong. “The math is simple. I need something safe and with return that can at least beat inflation.”

Depositors such as Lin bought 16.5 trillion yuan of what banks call wealth-management products in 2011, more than double the amount a year earlier, according to Benefit Wealth Co., a Chengdu-based data supplier which tracks the market. At the same time, deposit growth at Chinese banks last year slowed to 12.7 percent after rising 20 percent in 2010, central bank data show.

In January, depositors pulled 800 billion yuan from savings accounts, about 1 percent of the total, the central bank reported. It was the largest monthly decline in at least 12 years, according to data compiled by Bloomberg.

‘Cash Pressures’

The trend may undermine the stability of the $1.8 trillion banking system, say analysts including Charlene Chu, a Beijing- based senior director at Fitch Ratings Ltd. That’s because money moved out of savings accounts into wealth-management products no longer counts as deposits, reducing the ability of banks to lend. Having to pay higher returns also could force banks to borrow, driving up the interbank rate.

“Before the crisis, banks had this never-ending deposit base that was immobile and just constantly growing,” Chu said. Now, “for the first time, a large number of Chinese banks are beginning to face cash pressures, and fewer resources are available today than in the past.”

Chinese banks often set the maturity date for wealth- management products at the end of the month so the cash can be re-categorized as savings to meet month-end, loan-to-deposit- ratio requirements, said Sheng Nan, a Hong Kong-based analyst at CCB International Securities Ltd., the investment-banking unit of the nation’s second-largest lender.

Yu Baoyue, a spokesman for Beijing-based China Construction, declined to comment about the bank’s deposits or its accounting practices.

Supplementing Returns

To pay higher returns for these wealth-management products, most banks invest the proceeds in the money market and supplement the returns they get by drawing on their balance- sheet assets, using money earned from new product issuance, or borrowing funds from the interbank market, Chu said. Money- market investments on Feb. 16 were paying banks the Shanghai interbank offered rate, or Shibor (SHIF3M), of 5.28 percent annually over three months. The Shibor rate, the cost of lending among Shanghai banks, is a gauge of the cash firms have on hand to lend to each another.

“As this activity grows and you have more and more payout to meet, whatever resources you have on hand that would normally go to lending are increasingly going to pay off these other obligations,” Chu said. “It’s drawing away a lot of resources from credit.”

Riskier Products

Products invested in the money market typically require that cash be invested for a specific period of time in exchange for a return implicitly guaranteed by the bank. Sales increased 77 percent last year, according to Benefit Wealth, and now make up 54 percent of China’s wealth-management products, up from 40 percent a year earlier.

Other products offered by banks don’t have implicit guarantees of returns or principal. Considered riskier, they invest in stocks, property, loans, yuan and foreign currencies, returning as much as 10 percent annually.

One such product based on stocks and mutual funds and sold by Industrial & Commercial Bank of China Ltd., the nation’s largest lender, lost 16.5 percent of its value when it matured in January after two years, making it the worst performer among such investments so far this year, Beijing Business Today reported on Jan. 13.

“People will realize that these investments are not as safe as they perceived them to have been in the past,” Mike Werner, a Hong Kong-based analyst at Sanford C. Bernstein & Co. wrote in a note to clients on Feb. 9.

Chinese ‘Lifeblood’

China has the world’s highest savings rate at more than 50 percent of the nation’s economic activity. Of the 80.1 trillion yuan in deposits, 46 percent comes from households and 35 percent from companies, according to the People’s Bank of China. The central bank has maintained the one-year deposit rate at 3.5 percent since July, keeping it below inflation for the longest stretch in 16 years.

“Deposits are the lifeblood of Chinese banks,” said Wilson Li, a Shenzhen-based analyst at Guotai Junan Securities Co. (GJSZ) “Since the interest rate is still fixed by the government, the best banks can do to retain customers is to offer those high-yield, wealth-management products as quasi-substitutes, even though sometimes that is a money-losing business.”

‘Deposit Flight’

Last year’s 12.7 percent deposit-growth rate was the lowest since the government opened up its economy in the late 1970s, according to Werner. New lending this year may not exceed 7.7 trillion yuan because of the deposit constraints, he estimates, lower than the forecasts of between 8 trillion yuan and 8.5 trillion yuan by bank economists surveyed by Bloomberg. New lending in 2011 was 7.5 trillion yuan.

Chinese banks made 738.1 billion yuan of new loans in January, the lowest lending for that month in five years. The industry’s loan-to-deposit ratio climbed to 69 percent at the end of January, the highest since 2005, according to Werner, indicating that banks don’t have much room to grow their loan books. Banks are restricted to lending no more than 75 percent of their deposit base.

“Deposit flight will limit banks’ ability to extend lending and support economic growth,” said Ken Peng, a Beijing- based economist at BNP Paribas SA.

Hu Huaibang, chairman of Bank of Communications Ltd., the nation’s fifth-largest lender, said this month that Chinese banks face rising pressure to attract savings in 2012 and that the industry’s high profits of the past cannot be sustained.

Giving Away Gold

Premier Wen Jiabao, who has pledged to fine-tune policies to support growth in the world’s second-largest economy, cut lenders’ reserve requirements in December for the first time in three years to give banks resources to boost credit.

Shares of China’s eight largest publicly traded banks have gained an average of 14 percent this year in Hong Kong, after dropping 17 percent in 2011.

Lenders are going all out to attract depositors shopping for rates that beat inflation. Shenzhen Development Bank Co. (000001) is giving away gold necklaces from Hong Kong jeweler Chow Tai Fook to those willing to park at least 600,000 yuan with the bank, according to Ke Jieru, a manager at the Shenzhen-based bank’s Shanghai branch. Such depositors will also be eligible to buy a 90-day investment product with an expected annual return of 6.6 percent, she said.

Bank of Communications, based in Shanghai, is granting its best customers, or those depositing at least 500,000 yuan over three months, a 5 percent discount on the five-year benchmark lending rate of 7.05 percent when buying their first homes. It’s also offering a 140-day wealth-management product with a return of 5.3 percent.

Warning Lenders

The China Banking Regulatory Commission has repeatedly warned lenders over the past year about the risks of sales of high-yield wealth-management products and banned them from selling products with maturities of less than one month. The regulator in June also banned lenders from paying investors the expected rate of return by using profits earned from other business segments.

Only 37 out 15,038 wealth-management products failed to meet the highest expected rate of return stated in banks’ marketing brochures last year, Benefit Wealth data showed. All 37 were based on riskier investments such as stocks.

The Shanghai Composite Index (SCHOMP)’s 33 percent drop in 2010 and 2011 made it the worst performer among the world’s 10 biggest markets.

Chinese investors say they believe the government will make good on investment promises by the banks, even implicit ones for the money-market-invested products -- particularly by state- owned entities such as China Construction.

“For me, safety is a priority, so that’s why I choose investment products sold by banks,” said Lin, the retired accountant. “They’re government-owned, aren’t they? I don’t want to make the same mistake I did years ago by putting money into the stock market.”

To contact Bloomberg News staff for this story: Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net

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