Don’t Say You Weren’t Warned About China’s WMPs: QuickTake Q&A

Alarm bells are ringing as Chinese citizens pour their savings into wealth-management products, a market that has tripled to $3.8 trillion in just three years. So what’s the problem? Chinese corporate bonds, which form a hefty chunk of the assets held by WMPs, are tumbling. And if the slump continues, banks that offer WMPs may have to dig into their own cash to repay holders of maturing WMPs. Add to that, any attempts to sell assets to meet redemptions may exacerbate the bond rout. The People’s Bank of China has taken note, as has the nation’s banking regulator.

1. What’s the worry?

Like mortgage-backed securities were in the U.S., WMPs are building blocks of a shadow-banking system that exists largely off banks’ balance sheets. In China, a “history of bailouts” has persuaded many investors that WMPs are implicitly guaranteed by the issuing bank or the government. There are multiple risks for the financial system. Banks may face a liquidity crunch if investors turn cold on the products, which mostly have terms of six months or less. Lenders use WMPs in some of the financial engineering that helps them to sidestep lending restrictions and capital requirements. WMPs are increasingly investing in each other, meaning one soured product could infect others.

2. So what are the authorities doing?

Starting this year, the PBOC will require banks to account for off-balance sheet WMPs in assessing their risks and overall credit growth. The move will curb lenders’ ability to raise more WMPs to repay maturing products. About 56 percent of WMP assets are invested in bonds and the money market. And China International Capital Corp. estimates such plans hold more than 50 percent of all outstanding Chinese corporate bonds. Meantime, President Xi Jinping and his top economic policy makers pledged in December to prevent and control financial risk in 2017.

3. Why are WMPs so hot with investors?

Issued by banks, WMPs have emerged as a key tool for lenders to attract funds. Investors are lured by yields of 3 to 5 percent, compared with 1.5 percent for one-year bank deposits. The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep the WMPs off their balance sheets provided the products are not principal-guaranteed, which most are not.

4. How much money is involved?

The outstanding value of WMPs rose to 26.3 trillion yuan, or 38 percent of China’s gross domestic product, at the end of 2015, from 7.1 trillion yuan three years earlier, according to China Central Depository & Clearing. Much of the growth came in open WMPs, which are extra appealing to investors because they can be redeemed at any time, Bank of America Corp. reported. Mid-tier banks such as China Merchants Bank and China Everbright Bank are especially dependent on the products for funding.

5. What steps have already been taken?

The China Banking Regulatory Commission drafted rules on WMPs in July, seeking to limit the involvement of smaller banks and ensure that lenders have adequate capital for potential losses. The rules are yet to take effect. Besides public warnings on WMP risks from the likes of Xiao Gang -- the former head of the securities regulator -- the authorities have had a series of clampdowns. In 2013, the China Banking Regulatory Commission capped WMPs’ investments in “non-standard” credit assets, arrangements used by banks to get around restrictions on lending. In later steps, officials said WMPs sold to retail investors couldn’t invest in equities or in nonperforming loans. The PBOC also told lenders it would limit their outsourcing of the management of WMPs.

6. What do experts and markets say?

Bank of America Corp. strategists warned that “a liquidity crunch in China’s shadow banking sector over the next year or two is a genuine risk.” Banking analyst Charlene Chu says WMPs are defying market gravity: “The stock of Chinese banks’ off-balance-sheet WMPs grew 73 percent last year. There is nothing in the Chinese economy that supports a 73 percent growth rate of anything at the moment.” Still, for all the risks, WMPs so far remain profitable for investors and the institutions who manage them.

The Reference Shelf

— With assistance by Laurence Arnold, and Jun Luo

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