Wealth Management Products and Financial Repression
There's quite a bit of buzz surrounding the rapid increase of wealth management products (银行理财产品) in China. What role do these products play in China's financial system and what risks do they present to financial stability?
Wealth management products (WMPs) are a relatively new type of financial instrument that act as an alternative to traditional savings accounts. Investors purchase WMPs that have a maturity of anywhere from several days to several years. Short-term WMPs (less than 3 months) are typically purchased by investors who place a high value on liquidity and account for a large proportion of the total, perhaps around 80%.
Short-term WMPs typically offer interest rates in the 3-5% range, while longer-term products (greater than 6 months) often offer interest rates twice as high. The buy-in price for many of the more common WMPs is typically around 50,000 RMB, not exactly cost prohibitive but expensive enough to keep low-end savers away. Recently, banks started offering a whole new class of "high-end" WMPs targeted at wealthy investors that have significantly higher buy-in prices (1-3 million RMB) and interest rates in the double digits.
Demand for WMPs has exploded, with their issuance for the first half of the 2011 exceeding the issuance for all of 2010. At the end of June, the amount of money in WMPs stood at 3.57 trillion yuan, around 5% of China’s total banking deposits.
The risks for both investors and banks entailed in these investments are unclear. Banks funnel much of the money raised by WMPs to weakly regulated trust companies. In turn, trust companies invest in private equity, real estate ventures, and construction projects. For many WMPs, the bank merely acts as a middleman, capturing a hefty fee for facilitating the transaction.
Most WMPs are marketed as low-risk investments, with principal (and sometimes interest) guaranteed. However, there are numerous reports of less scrupulous products where loss provisions are hidden within the fine print. The rapid growth of WMP has led many analysts to compare them to Ponzi schemes and persuaded some international banks to stop issuing them altogether.
WMPs can best be thought of as a mechanism for escaping financial repression. China's persistently high inflation this year, 6.2% last month, has pushed savers to seek higher yields wherever possible in order to prevent the real value of their savings from eroding away.With the stock market tepid, negative real interest rates in savings accounts, and a moderation in house price inflation, WMPs are one of the few remaining avenues for savers who want to earn a decent return. The banks, while losing out on deposits, have been eager to offer these products in order to capture transaction fees.
Some analysts have viewed the spread of WMPs favorably, noting that the interest rates offered by WMPs are closer to equilibrium and therefore a step in the direction of long-term financial reform. Nevertheless, the financial sector faces potentially serious problems as WMPs push banks into a world of competitive interest rates outside of traditional regulatory structures. Without proper regulation, the potential for corruption and misinvestment is high.
Moreover, trust companies are funneling much of the money raised by WMPs into investments that have high exposure to macroeconomic shocks (construction, real estate, equity). With many of the products, the issuing banks guarantee the principal, putting their balance sheets at risk. Even when banks are not directly liable, WMPs are problematic because they reduce the effectiveness of regulatory tools used by the government to manage the economy as well as create new avenues for the concentration of risk.
On June 29, CBRC issued draft guidelines for commercial banks on the sale of WMPs and in August restated its determination to regulate these products. Despite these moves, the government has yet to move forward with any significant crackdown.
With interest rates on demand deposits and 1 year deposits at .5% and 3.5% respectively, its no wonder savers jump at the chance to buy investment products that offer interest rates three times as high. Expect WMPs to be popular as long as inflation stays high and property prices remain subdued.