We've followed the development of wealth management products (WMPs) with interest on this blog. These financial products act as alternative to deposits, soaking up funds from investors seeking to escape low interest rates on bank deposits. While many analysts have greeted the proliferation of WMPs as backdoor interest rate liberalization, we've been more skeptical.
A product offering higher rates to depositors sounds good in theory, but it’s problematic in practice. WMPs are very short-term in nature, with 60 percent maturing in three months or less. These short-term financial products are being used to fund what are often projects with long-term payback periods, such as infrastructure and real estate.
The potential for a financing mismatch is quite high and payback for many WMPs is dependent on new issuances. Xiao Gang, the chairman of the Bank of China, writes that the issuing of new WMP to pay off expiring ones has the characteristics of a Ponzi scheme and is potentially destabilizing to the financial system.
The risk is spread further than just a funding mismatch. Banks have been eager to sell these products in order to capture fees and to have these products revert back to deposits when they expire the day before the end of month or quarter (thereby improving their loan-to-deposit ratio).
Two-thirds of the WMPs sold do not guarantee the principle. WMPs without a principle guarantee are attractive to banks because they are off the banks’ books. Moreover, with unguaranteed WMPs, banks theoretically do not bear any risk if the WMPs perform poorly.
In reality many Chinese depositors have purchased these products under the assumption that they were endorsed and supported by the banks, in effect quasi-deposits. The transparency of what these products are investing in is quite limited and therefore difficult for purchasers to have a good sense of the risks they are taking.
If WMPs begin to default in large numbers, investors are unlikely to give the banks a free pass. Just as there have been protests in front of the China Securities Regulatory Commission (CSRC) when stocks have lost money, the banks, and by extension the government, will find themselves under pressure if the WMP market goes south.
Our estimate for the current stock of WMPs outstanding is 11.5 trillion renminbi. To put this in perspective, this is about 13 percent of total deposits and growing. This number is big enough to start having implications for the stability of the Chinese financial system and the trend is going in the wrong direction. The China Banking Regulatory Commission (CBRC) and Peoples Bank of China can reduce risks emerging from the proliferation of WMPs by strengthening regulation and can protect investors by enacting tougher transparency requirements. The long-term solution, however, is to continue reforming the financial sector so that savers have better options, thereby reducing the popularity of WMPs.