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

China’s banking regulator is proposing tighter rules for a $3.5 trillion market in wealth-management products, a person with knowledge of the matter said. The move comes after bank analysts, ratings agencies and a former head of the securities regulator all rang alarms in recent years over Chinese citizens pouring their savings into WMPs, which pay interest at rates more generous than bank deposits. WMPs are widely regarded as having the implicit backing of banks. Their explosive growth is one reason some people think China is a debt bomb.

1. What’s the latest?

News of draft regulations from the China Banking Regulatory Commission jolted Chinese stocks on Wednesday, partly because some WMPs invest in equities. The new rules are intended to protect mass-market investors, limit the involvement of smaller banks and ensure that lenders have adequate capital for potential losses, said the person, who asked not to be identified discussing private information.

2. Why are WMPs so hot?

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.

3. How much money is involved?

The outstanding value of WMPs rose to 23.5 trillion yuan, or 35 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 Co. 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 Co. and China Everbright Bank Co. are especially dependent on the products for funding.

4. 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.

5. What steps have already been taken?

Besides public warnings on WMP risks from the likes of Xiao Gang -- who was then chairman of Bank of China Ltd., later 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 People’s Bank of China 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 in February 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

  • A Bloomberg Gadfly column on the dangers in China’s hidden loan boom. 
  • A Bloomberg QuickTake explainer on China’s debt bomb.

— With assistance by Laurence Arnold, and Jun Luo

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