China’s WMPs attract investors despite rules clampdown

China's attempt to rein in unregulated lending activities has led to a decline in banks' wealth management products (WMPs) in the first half of the year, but industry experts believe investors retain a strong appetitie for such products at a time when deposit rates are low and liquidity conditions are expected to remain tight.

"Chinese shadow banking activity stopped growing in the first half of 2017 because of both a fall in the issuance of higher risk instruments such as the banks' WMPs, and non-bank financial institutions' asset management plans," said Michael Taylor, Moody's managing director and chief credit officer for Asia Pacific.

Broad shadow banking assets barely grew in the first six months, reaching Rmb64.7 trillion ($9.7 trillion)  compared with Rmb64.4 trillion at end-2016, according to a Moody’s report issued on November 6.

The outstanding balance of banks' WMPs, a key component of shadow credit in China, have declined to Rmb28.4 trillion as of June 2017 from Rmb 29.1 trillion at the end of last year. The implied year-on-year growth rate was 8%, compared to 23.6% in 2016.

This shows that recent regulatory measures are having some effects in reducing financial system interconnectedness and addressing vulnerabilities created by increasingly complex and opaque funding chains, the report shows.

However, Chen Shujin, banking analyst at Huatai Securities, told AsianInvestor that she believes that issuance of WMPs should have bottomed out and may reverse course. 

The fall in WMPs in the first half was mainly caused by less demand from interbank investors - banks purchasing the WMPs from other banks. It was largely a result of regulators' tighter oversight on the interbank business, while corporates and retail investors' demand on WMPs have always been strong and will likely remain so, she said.

"Liquidity is relatively tight, yield levels of WMPs have been climbing, and deposit rates are low, as investors for sure they want to buy WMPs," she said.

China wants to deleveage its economy and will therefore likely maintain a relatively tight monetary policy. The expected yield for WMPs has been on a rising trend since the beginning of this year and stood at 4.6% in September, while deposit rates are very low now, she said.

The central bank lowered the one-year deposit rate to 1.5% from 1.75% last month.

Regulatory clampdown

Since mid-2016, regulators have strengthened rules on WMPs and included banks' businesses with these products in the central bank’s Macro Prudential Assessment (MPA) framework. They have also introduced more stringent restrictions on transactions between banks and non-bank financial institutions (NBFIs).

In addition, tighter regulations on NBFIs' asset management business have been introduced. In May this year, the leverage of asset management schemes was ordered to be lowered to 1 to 3 times based on the underlying assets, against the 10x previously.

"Following the 19th Chinese Communist Party Congress, financial-sector regulation will likely continue to restrain the growth of shadow banking activities and address some key imbalances in the financial system," said George Xu, a Moody's Analyst.

However, Chen believes that despite the curb on shadow banking activities, investors' thirst for higher yield products should be enough to offset the impact and issuance of such products will continue.

Moody's also noted that "regulatory measures tend to end up encouraging financial innovations for evading tighter regulations".

China's shadow banking system 

Banks and NBFIs, including trust companies, securities firms, mutual funds, etc, play important roles in the shadow banking system in China.

NBFIs are intermediaries who lure investors into buying their trust products and asset management plans, and then channel the investments into non-standard credit assets, such as loans to local government financial vehicles (LGFVs) and corporate borrowers, especially those in overcapacity sectors.

A big part of the investments come from banks’ off-balance sheet WMPs. Shadow banking assets funded by banks’ WMPs and NBFIs’ fund products totaled Rmb 27.5 trillion (Rmb 15.3 trillion and Rmb 12.2 trillion each) as of mid-2017, accounting for 43% of the Rmb 64.7 trillion broad shadow banking assets, according to the Moody's report. 

Banks use its own funds to purchase the financial products packaged by these intermediaries and book it under receivable investments, effectively taking on the credit risk of the underlying corporate borrowers and circumventing rules on loan provisions, according to a Deutsche Bank report.

Note: the chart was produced by Deutsche Bank in a report released in 2016, and the Rmb21 trillion in the chart showed Deutsche's estimate on the shadow credit from Chinese banks as of mid-2016.