There’s something of a vicious circle in China’s relationship with wealth management products (WMPs). Just as the central bank cracks down on the issuance of these off-balance sheet products — partly by taking a tough stand in the interbank market — banks are finding themselves having to issue even more of them to meet payment obligations on the Rmb1.5 trillion (US$245 billion) of WMPs maturing in June.
That arrangement is pretty unhelpful for Chinese regulators, who want to break from precisely this pattern. But this is a very complicated process that takes in China’s entire financing landscape rather than just the irresponsible issuance of high-yielding investment products.
Regulators have got into this predicament because the People’s Bank of China (PBoC) has sought to starve the shadow banking industry of its funding by deliberately keeping money market liquidity low. This in turn drove rates up to a 10-year high last week, making it unfeasible for mid-tier commercial banks — the main target of this exercise — to borrow from within the system.
The main message, delivered via a strongly worded statement from the PBoC that was reminiscent of a father lecturing his teenage children about responsible cash management, is that the banking system cannot rely on the central bank for liquidity and bailouts.
Not much is going to change for the moment, though. With Fitch estimating that Rmb1.5 trillion WMPs are due for maturity in the last 10 days of June, banks have had nowhere else to go for cash but to the shadow banking market — issuing yet more WMPs and steer clear of ultra-high Shibor rates.
Not only that, but they’ll have to pay higher and higher yields to attract investors amid the liquidity shortage. And that means an even higher cost of funding for the banks when the new crop of WMPs falls due.
The alternative is to package into the new WMPs even riskier assets that naturally offer a higher yield. But these are exactly the types of products that regulators want to stamp out.
Opportunity knocks
All of which means that it doesn’t look like regulators are going to have much going their way right now. But it’s probably more productive to see this as a rare opportunity to reform the wealth management product market entirely, while banks are at Beijing’s mercy.
While the China Banking Regulatory Commission (CBRC) — the main regulator for this market — has sought to clamp down on the issuance of WMPs because of increasing risk exposure and fear of default, it also recognises the integral role that WMPs play in social financing. After all, banks’ ability to sell WMPs goes hand in hand with their ability to lend to private businesses and small-to-medium-sized enterprises (SMEs). This is a crucial goal of the State Council.
Instead of eliminating the sale of all WMPs — which would cause nothing less than systemic collapse — the CBRC has targeted the riskiest WMPs with more weighty regulation. In March it ruled that no more than 35% a bank’s WMPs can be backed by illiquid assets, such as trust loans and bank bills. At least 65% of WMPs must be backed by liquid assets such as bank loans and bonds — to better enable investors to make informed decisions.
This move prompted WMP issuance to fall by 12.8% between March and April 2013, according to state-owned newswire Xinhua.
With banks desperate for funding, that drop is probably set to be reversed. But that does not mean that the CBRC cannot take more constructive action. It could, for instance, force off-balance sheet WMPs to move on-balance sheet.
The real problem with WMPs is not that they exist, but that they’re opaque by nature. Because they’re sold off-balance sheet investors have little clarity on WMPs’ underlying asset quality, and there’s no impetus for banks to disclose these specifications.
The CBRC should remedy this issue by starting light, ruling that banks must include the sale of WMPs backed by liquid assets on their balance sheet. Given the 35:65 ratio, this would already give regulators huge insight into the breadth of this market. Banks would be less hesitant to comply with the rule since their riskiest products would remain off-balance sheet. Only its WMPs with lower yields — some with interest rates near to deposit levels — would be disclosed.
New thinking
But even this ought to affect the way banks think about these products. First, they would probably have a more difficult time issuing more and more WMPs to cover the costs of their maturing ones because the entire process would be more transparent and open to scrutiny. Instead, they would be incentivised to adopt healthier cash management habits to repay WMP principal.
Eventually, banks could be asked to bring their remaining off-balance sheet WMPs on-balance sheet, but at least they would have had the opportunity to wind these investments down.
Analysts believe the market is heading in this direction, but as the dearth of liquidity in the market has made some banks desperate to raise cash, now might be a good time to start.
The CBRC and the PBoC’s overarching goal is to create a system in which companies in need of financing can obtain it, rather than bleeding banks dry in an effort to stamp out WMP sales. Creating stronger and more transparent infrastructure that gives investors and banks a better way to manage their cash positions is the best way to accomplish this.
Beijing is obviously in the mood to send a strong message to the banking community. It’s a good time for it to go even further.