Crunch Escalates as Money Funds Rival Shadow Banks: China Credit

A doubling in China’s money-market funds in the past six months is draining bank deposits and raising the risk of financial failures during cash crunches, according to Fitch Ratings.

The assets under management of such plans surged to a record 737 billion yuan ($122 billion) on Dec. 31 from 304 billion yuan on June 30, said Roger Schneider, senior director at Fitch’s Fund and Asset Manager Rating Group. Yu’E Bao, managed by Tianhong Asset Management Co. and sold online by Alibaba Group Holding Ltd., offers an annualized return of 6.7 percent, compared with the 3 percent official one-year savings rate. Some funds are offering higher rates, with news portal marketing a product that targets 10 percent.

“Clearly, yields of 8-10 percent are not sustainable,” Schneider said in a Jan. 10 interview from Frankfurt. “They will definitely come with the risk, and the premium includes both credit risk and liquidity risk in what they buy. There are strong refinancing needs among corporate issuers this year and the credit profile is to some extent deteriorating.”

Funds investing in interbank deposits and short-term corporate paper have benefited from record money-market costs as the central bank engineered a cash crunch to stop excessive lending. Banks are selling more wealth-management products to stem the savings exodus, swelling the less-regulated shadow banking industry. Industrial & Commercial Bank of China Ltd. last week rejected calls to bail out a 3 billion yuan trust product it marketed to savers seeking high returns.

Cash Crunch

The benchmark seven-day repurchase rate jumped to a record 10.77 percent on June 20 and averaged 4.09 percent last year, from 3.50 percent in the previous year. It jumped 153 basis points today to 6.32 percent, the highest since Dec. 23, as demand for cash spiked before the Chinese New Year holidays and as banks parked corporate tax-payment funds with the PBOC. The similar U.S. dollar rate is 0.07 percent. Interbank deposit rates rose to 10 percent in December, and have stayed above 6 percent in January, according to Fortune SG Fund Management Co.

Premier Li Keqiang is letting the market decide bank lending rates after cheap loans fueled industry overcapacity and allowed local government debt to surge to 17.9 trillion yuan as of June 30. That’s up 67 percent from the end of 2010. The nation started the trading of negotiable certificate of deposits last month while the ruling party’s third plenary session in November said it would grant the market a “decisive” role in allocating resources.

Trust Concern

State-controlled banks have for decades benefited as rates set by the government created a 3 percent spread between what they earn from loans and what they pay on one-year deposits. While lending rates have been liberalized, savings rates are still under state control, encouraging banks to market so-called WMPs and trust funds that offer higher returns as well as higher risk. Assets managed by China’s 67 trusts soared 60 percent to $1.67 trillion in the 12 months ended September, dwarfing the scale of money-market funds.

The State Council has tightened control on shadow banking with rules targeting off-the-books loans and enforcement of current regulations. While aggregate financing, the broadest measure of new credit, fell to 1.23 trillion yuan in December from 1.63 trillion yuan a year earlier, it held steady from November even as commercial bank loans slumped to 482.5 billion yuan from 624.6 billion yuan the previous month.

More Regulated

Money-market funds are safer because the industry is closely regulated when compared with shadow-banking, said Wang Bo, head of marketing at Fortune SG Fund Management Co. in Shanghai. Such funds’ assets could exceed 2 trillion yuan by end-2014 if they draw 10 percent of household demand deposits, Victor Wang, a Hong Kong-based analyst at Credit Suisse Group AG, wrote in a Jan. 2 note. By 2020, they could reach 5 trillion yuan, or about 10 percent of the nation’s economy, according to the report.

“Disclosure and diversified investments make money-market funds more regulated and reliable, compared with other pooled investments like trusts and wealth-management products,” Wang said in an interview. “We can see the mark-to-market values of assets. This is impossible for trusts and WMPs.”

The surge in China’s borrowing costs is attracting foreign investment. The yuan has gained 2.7 percent in the past year, trading at 6.0524 per dollar as of 11:57 a.m. in Shanghai today. The 10-year government bond yield has risen 100 basis points to 4.60 percent. China’s economic growth slowed in the fourth quarter, with gross domestic product expanding 7.7 percent from a year earlier, the National Bureau of Statistics said today in Beijing, compared with 7.8 percent in the July-September period.

Long Overdue

Premier Li, who took office in March last year, needs to address some long overdue issues, including local government financing vehicles and shadow banking, according to a BofA Merrill Lynch Global Research report last week. It warned of a wave of possible defaults, with more than 100 billion yuan in products issued by mining-related trusts alone due this year.

“If an LGFV trust defaults, a psychologically very important event, we suspect that the trust market may tip over,” the report said. “We expect WMP yields will stay high until at least the Chinese New Year as the PBOC enforces its prudent monetary policy. At this level of funding cost, we suspect that some banks may be losing money on their WMP business.”

The central bank in June 2012 began allowing lenders to offer deposit rates capped at 110 percent of benchmark rates. The regulator left the ceiling intact this year even as it removed the floor on lending costs, saying that changes to rules for rates paid to savers were the “most risky” part of liberalization.

Funding Source

“Deposit rates remain an important funding source for banks, as it’s a cheap source,” Fitch’s Schneider said. As the cost of funds becomes higher for banks and money is traded between different vehicles, the availability of cash in the interbank market comes under strain, he said.

Yu’E Bao’s assets grew 35 percent to more than 250 billion yuan as of Jan. 15 from 185.3 billion yuan at the beginning of the month, making it the world’s 14th-largest money-market manager, according to the company, which oversees the largest mutual fund in China.

While money-market funds rated by Fitch are conservatively managed, the composition of assets in other plans is “not very transparent” and qualified money managers are “very scarce,” said Schneider. He estimates there are 90 so-called MMFs in China and only 10 have assets of more than 10 billion yuan.

As WMPs are restricted “the question is where is yield-seeking money going,” said Schneider. “In the June crisis, to provide liquidity has been difficult to some funds. There’s a strong reputational risks being involved. Because MMFs can invest in corporates issues, and although there hasn’t been any default in China, it can surely happen in the future.”

— With assistance by Helen Sun

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