China’s $3.6 Trillion Wealth Management Product Pool Threatens Banks

The continued rapid growth in wealth management products invested through Chinese banks could be a key and critical source of credit and liquidity risk for some financial institutions, according to a research report by Fitch Ratings.

The outstanding balance of wealth management products increased to RMB23.5 trillion (US$3.6 trillion) at the end of 2015, up from RMB15 trillion a year earlier.

An average of over 3,500 new products are issued every week during the year. Nearly three-quarters of these are non-guaranteed wealth management products, with over 60% of funds invested in wealth management products come from retail investors, attracted by the higher rates of return than that for ordinary deposits.

Wealth management products continue to grow faster than bank deposits. Wealth management products take up 16.8% of system deposits at end-2015, up from 13.6% at the end of the first half last year.

Those banks with large sales of wealth management products relative to deposits could face liquidity and funding pressures in the event of renewed market volatility.

Fitch believes that most common source of wealth management product repayment is through the issuance of new products, resulting in persistent rollover and payout pressure on banks.

Wealth management products issuance during 2015 topped RMB158 trillion, up from RMB114 trillion in 2014, highlighting the high churn rates of these products.

When banks are unable to roll over, they have to either draw on their on-balance sheet liquidity or borrow money from the inter-bank market to meet payouts.

Mid-tier banks are the most vulnerable. The outstanding balance of wealth management products issued by mid-tier banks surpassed that of state banks for the first time in 2015, accounting for a 42.2% market share versus 36.9% for state banks.

Notably, outstanding wealth management products accounted for over 40% of deposits for mid-tier banks versus just 15% for state banks.

This is a key source of credit and liquidity risk for mid-tier banks, given their thinner liquidity profiles and weaker loss-absorption capacity.

There are other risks from wealth management products beyond liquidity. They are typically managed directly by the banks, and issuance is often used by banks to offload assets from their loan books.

Most products reside off-balance sheet for much of their duration, and are tied to hidden off-balance sheet pools of assets. They have been used by some banks to support profit while masking asset-quality risks and leverage.

Therefore the growth in wealth management products could add to bank credit risks, especially with a history of banks bailing out investors in failed wealth management products.

Banks have also been increasingly investing in wealth management products on their own books in recent years, and capital invested in them has been channeled into equity markets and forms of mezzanine financing in addition to traditional fixed-return asset classes such as corporate bonds.

This could add to the aforementioned credit and liquidity risks by raising bank exposure to capital market volatility, says Fitch.

China Expert Network