China banking regulator wrestles with $2.9 trillion off-balance sheet WMPs

BEIJING (Reuters) - China’s banking regulator may be getting serious about how lenders provision for the more than 20 trillion yuan ($2.9 trillion) of wealth management products (WMPs) that have been issued as non-guaranteed off-balance sheet liabilities.

Shang Fulin, chairman of the China Banking Regulatory Commission (CBRC), answers a question at a news conference on the sidelines of the National People's Congress (NPC), China's parliament, in Beijing, China, March 12, 2016. REUTERS/Jason Lee

The China Banking Regulatory Commission (CBRC), in new draft rules released on Wednesday, demanded banks apply a more “comprehensive” approach to cover “substantive risks” related to off-balance sheet activities, or shadow banking.

The guidelines, which would replace 2011 regulations and are awaiting comment, proposed such measures as adding impairment loss allowances and properly calculating risk-weighted assets for off-balance sheet activity.

It was the latest measure announced by CBRC to curb shadow banking risks and address the rapid growth of WMPs, which amounted to 26.28 trillion yuan ($3.8 trillion) by end-June, data from the Banking Sector Wealth Management Product Registration and Custodian Centre showed. That amounts to around 39 percent of China’s GDP in 2015.

About 77 percent, or 20.18 trillion yuan, of the products are non-guaranteed bank WMPs, a major component of shadow banking activity, the data showed.

CBRC Chairman Shang Fulin warned banks in September the rampant growth of their off-balance sheet operations must be curtailed, and represented a “hidden credit risk that potentially threatens financial safety”.

The growing volume of opaque shadow banking transactions, and the absence of stricter reporting standards or requirements for capital provisioning, represented a possible systemic risk, analysts have warned.

“The new guidance is good, especially at a time when WMPs are growing too quickly and the problem of inflexible payments cannot be solved,” said a general manager in the financial institutions department of a major Chinese bank.

Inflexible payments refer to the widely held expectation that banks will stand behind their products, absorbing investment losses even for non-guaranteed WMPs. It is still rare for a Chinese bank to pass on an investment loss to customers out of concern for reputational risk.

Senior bankers cautioned, however, that even as WMP issuance may slow they don’t expect a “disruptive impact” from the new regulations.

“It depends on how the rules will be executed,” said the head of risk management at a mid-tier joint-stock bank based in northern China.

China’s mid-tier and small lenders, which have raised a greater proportion of their funding using WMPs, are more vulnerable to off-balance sheet liquidity risks.

One important obstacle is capital.

A very strict interpretation of the draft regulations, requiring banks to hold reserves against all off-balance sheet issuance, would require banks to raise as much as 1.7 trillion yuan to maintain current capital levels, said Jack Yuan, a banking analyst at Fitch.

“The incentives for banks to issue more off-balance sheet WMPs still exists,” said Yuan. “There’s nothing in these rules that disincentivizes banks from continuing on with more off-balance sheet activity.”

“It’s like driving a car,” said a risk manager at another mid-size lender. “If you don’t follow the rules, there’s a mess. But if you follow the rules, that doesn’t mean you have to slow down.”

Reporting by Shu Zhang and Matthew Miller; Editing by Jacqueline Wong