China expands crackdown on wealth management fund pools to non-bank financials

SHANGHAI Tue May 14, 2013 5:17am EDT

Chinese Yuan bank notes are seen in a vendor's hand at a market in Beijing April 10, 2013. REUTERS/Kim Kyung-Hoon

Chinese Yuan bank notes are seen in a vendor's hand at a market in Beijing April 10, 2013.

Credit: Reuters/Kim Kyung-Hoon

SHANGHAI (Reuters) - China's central bank closed a loophole used by non-bank financial institutions to conceal risks hidden in high-yielding but opaque wealth management products (WMPs), according to a statement published on the website of the China Foreign Exchange Trade System (CFETS) on Tuesday.

The new restrictions mark an extension of a similar policy sources applied to commercial banks last Friday, which prohibited them from trading bonds between their own proprietary accounts and the WMPs they manage for clients, a practice called fund pooling.

By shifting bonds back and forth between their own balance sheets and the WMP accounts they manage for clients, investment managers can deliver promised payouts to WMP investors, even if the underlying bonds have not yet matured or have declined in value.

The rise of WMPs has been fuelled by Chinese depositors' hunger for yields above the central bank's benchmark deposit rate, currently set at 3.0 percent for one year.

Economists say Beijing has tolerated the explosive growth in the sector because WMPs can deliver higher yields to ordinary investors, serving as a backdoor way to liberalize interest rates and increase the propensity to consume.

In addition to banks, non-financial institutions such as brokerages, insurers, trusts and fund management companies have leapt to meet investor demand for WMPs, and many banks have allowed non-bank firms to sell their WMPs through bank sales counters.

This practice appears to have confused some investors, who believed the WMPs were actually guaranteed both by the bank and ultimately the government, which caused a political ruckus when several third-party WMPs sold through banks collapsed amid fraud allegations in 2012.

Despite the existence of WMPs promising double-digit returns based on concert revenues or ham sales, analysts say that most of them are backed by low-risk conventional corporate bonds.

But industry observers are concerned that even if the bonds themselves are high quality, the practice of fund pooling is akin to a Ponzi scheme because of the way such pools allow inflows from the sale of new products to deliver the promised returns on previously issued products.

The complex and interlocking nature of such pools, supporting a wide variety of different WMPs with different maturity periods, also exposes banks to significant liquidity risk, analysts have warned.

Standard & Poors estimated that WMPs offered by Chinese banks grew 56 percent in 2012 to 7.12 trillion yuan ($1.16 trillion), equivalent to 7.6 percent of the system's total deposits at the end of the year.

($1 = 6.1309 Chinese yuan)

(Editing by Kim Coghill)