Shadow Bank Assault Backfires as Rates Lure Cash: China Credit

China’s crackdown on shadow banking is backfiring as a plunge in stocks prompts individual investors to pump increasing amounts of cash into wealth management products that offer yields more than double the deposit rate.

A record 1,137 of the investment plans were sold by about 70 banks in the last two weeks, almost 50 percent more than the similar period ended June 14, according to Benefit Wealth, a Chengdu-based consulting firm tracking the industry since 2007. China Minsheng Banking Corp., the nation’s first privately owned lender, last week sold a 35-day product with an annualized yield of 7 percent.

The People’s Bank of China allowed the worst cash crunch in at least a decade and warned lenders to avoid raising short-term money to finance long-term loans. While the two-week surge in borrowing costs was designed to reduce such risky positions, the initial impact was to drive investors out of a plunging stock market and into the so-called shadow banking system. The Shanghai Composite index fell 14 percent in June as the benchmark overnight money market rate touched a record 13.91 percent on June 20.

“Wealth management products keep getting money from investors who want some decent returns on their savings but don’t want to lose any more money in the stock market,” said Chen Xingyu, a Shanghai-based analyst at Phillip Securities Group, part of PhillipCapital Ltd. which oversees more than $22 billion in assets. “Clearly, there are credit risks associated with these products. The PBOC’s strategy is to ask banks to do a better job in risk management and to limit the rapid growth of the market.”

Rising Trend

The outstanding amount of wealth management products rose by 500 billion yuan ($82 billion) to 13 trillion yuan in the first five months of this year, accounting for 16 percent of China’s deposits, according to estimates published by Fitch Ratings on June 10. This compares with a 4 trillion yuan increase for all of last year, the rating company said. Products linked to bonds and money market investments were offered at an average yield of 5.11 percent last week, up 96 basis points from a month earlier, according to Benefit Wealth. China’s one-year benchmark deposit rate is 3 percent.

Regulators are forcing trust funds and wealth management plans to shift assets into publicly traded securities, seeking to get a firmer grip on investment by property developers and local-government finance vehicles. The China Banking Regulatory Commission told banks in March to cap investments of client money in debt that isn’t publicly traded at 35 percent of all funds raised from the sale of wealth products.

Underlying Assets

The crackdown has had some success. Official data on June 9 showed that trust company lending, often repackaged into wealth products and sold to investors, fell to 99.2 billion yuan in May. This accounted for 8.4 percent of aggregate financing, a measure of credit that includes all loans, stock and bond sales, from 16 percent in December.

Although the country’s overnight and seven-day repurchase rates have come down from the highs of June 20, the central bank may continue to limit money supply, according to Wilson Li, a Shenzhen-based analyst at Guotai Junan Securities Co. It will also restrain the expansion of shadow banking vehicles.

“The surge in issuance was driven by investors’ demand as rises in the money rates lift the returns on these products,” he said. “But, in the long run, the supply side will be the deciding factor on the future of the market as the government controls its expansion. Some of the mid-sized banks have already cut their issuances.”

Money Market

China’s one-day repurchase rate, which measures interbank funding availability, rose 60 basis points, or 0.60 percentage point, to 3.37 percent in Shanghai as of 10:01 a.m. according to a weighted average compiled by the National Interbank Funding Center. That’s higher than the 2.91 percent average over the past year.

Credit markets have settled with the easing of the cash crunch. The yield for 10-year government debt has dropped 18 basis points to 3.53 percent from a 19-month high on June 20, Chinabond data showed. The yuan appreciated 1.2 percent last quarter and 0.06 percent today to 6.1273 against the dollar, according to the China Foreign Exchange Trade System.

The cost of insuring sovereign notes in China against non-payment has declined after reaching a 17-month high of 147 on June 24, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. It rose seven basis points to 123 yesterday.

Stock Slump

The benchmark Shanghai Composite index of stocks plunged the most last month since August 2009 and fell 0.7 percent today. Chinese shares are near the cheapest compared with AAA-rated bonds since 2006. Yields on 10-year AAA-rated corporate notes rose seven basis points in the past month to 5.11 percent on July 2, ChinaBond data show. That’s 4.2 percentage points less than the Shanghai Composite Index’s earnings yield, or profit per share divided by the share price.

The slump hasn’t made stocks attractive because the extent of China’s economic slowdown and its control over escalating debt is unclear, according to Coutts & Co., which has a neutral to underweight position on the country’s shares.

“I don’t think the policy makers are in so much control as they may have been in the past,” said Gary Dugan, Singapore-based chief investment officer for Asia and the Middle East at Coutts, which counts Queen Elizabeth II among its clients. “It’s not a grownup country if you have to ramp up your interest rates to slap everyone down.”

Slowing Economy

Goldman Sachs Group Inc. last month cut its 2013 expansion forecast for the Chinese economy to 7.4 percent from 7.8 percent, while China International Capital Corp. lowered its projection to 7.4 percent from 7.7 percent. Coutts’ Dugan said GDP growth will stay below 7 percent.

Chinese investors opened an average of 92,015 new stock accounts per week in June, according to data compiled by Bloomberg. That compared with the average of 170,219 in March, one month after the Shanghai Composite Index rose to the highest this year. The measure’s market capitalization plunged to 14.11 trillion yuan yesterday from 16.25 trillion yuan on May 31.

Shadow lending, which allows banks to bypass controls and capital requirements, is flourishing in China because an estimated 97 percent of the nation’s 42 million small businesses can’t get bank loans, according to Citic Securities Co. The industry may be valued at 36 trillion yuan, or 69 percent of gross domestic product, JPMorgan Chase & Co. estimated in May.

Bad Loans

Chinese commercial banks’ outstanding non-performing loans rose 20 percent to 526.5 billion yuan at the end of the first quarter from a year earlier, accounting for 0.96 percent of total lending, according to data from the CBRC.

Those figures don’t reflect the real amount of debt because of the ways in which banks move loans off their books, Charlene Chu, Fitch’s Beijing-based head of China financial institutions, said in April. Some loans are bundled and sold to savers as wealth-management products, she said. Other assets are offloaded to non-bank institutions, including trusts, to lower bad-debt levels.

“The central bank is trying to clean up the house and put the industry back on the right track,” said Phillip Securities’ Chen. “But, in the foreseeable future, Chinese people are just going to keep buying those products as they’ll probably make more money with less risk than betting on stocks themselves.”

— With assistance by Andrea Wong, and Jun Luo

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