Bank of America thinks China's wealth management products could be a systemic risk

Reuters/Bobby Yip

The risk of a liquidity crisis in China’s bank-run wealth management product (WMP) space, the biggest “deposit” base of China’s shadow bank, is growing at an alarming rate according to Bank of America Merrill Lynch’s February 29 report on the sector.

According to figures from the Annual Report of the Bank WMP Industry, the total value of assets in WMP products increased 56% year-on-year during 2015 to a total of 23.5 trillion yuan (USD3.59 trillion). Last year’s growth even exceeded that of 2014 which had already set a high bar. In 2014, the balance of WMPs grew from 10.2 trillion yuan to 15 trillion yuan, up 47.25% year-on-year.

The banks reporting the greatest growth are joint-stock banks which reported 74.8% growth in WMP balances last year. City commercial banks saw growth of 80.6%, but this was off a much lower base. The WMP balance issued by city commercial banks hit 3.07 trillion yuan during 2015 compared to the 9.91 trillion yuan in WMP balance issued by joint-stock banks.

On the other hand, the big four state-owned enterprise banks’ WMP balance rose by a more moderate 53.2% 8.67 trillion yuan while foreign banks’ balance declined by 25.6% to 0.29 trillion yuan.

Reuters/Bobby Yip

China’s shadow banking addiction

The sheer volume funds making their way into WMP products, which form the biggest “deposit” base of China’s black box shadow bank, makes the system more to liquidity shock and duration risk according to Bank of America.

The balance of WMPs that are lending to the shadow banking sector and can be redeemed at will increased, by 97% last year to 10.32 trillion yuan, just under half of the total product market. And with the number of open WMPs increasing, the possibility of a duration mismatch in the shadow banking sector is skyrocketing, making the system more prone to a liquidity shock.

If WMP buyers decide to ‘go on strike’ for whatever reason, a liquidity crunch in the shadow banking sector could quickly develop.

What’s of more concern vast is the majority of WMPs issued by banks are still sold with the so-called “expected return”, which is primarily viewed as promised return by WMP buyers. In fact, only 13% of Chinese bank WMP’s are priced based on NAV. These numbers imply that most Chinese investors buying these WMPs expecting long to lose money. Only 44 WMPs lost money for investors last year (around 0.03% of matured products) most of which were issued by foreign banks. As Bank of America points out, this loss ratio appears unusually low.

High net worth individual investors are the biggest buyers of these products, accounting for 13.34 trillion yuan of the WMP balance, 56.6% of the total. Institutional investors and inter-bank transactions accounted for 30.6% and 12.8% respectively.

Reuters/Bobby Yip

WMPs underlying asset base raises concerns

Of the total 23.67 trillion yuan worth of assets held by WMPs as of December rates products (government bonds) accounted for 4.07%; credits (corporate bonds etc.), 25.42%; money market products (short term rates and credits largely), 21.50%; cash and deposits, 22.38%; non-standard debt instruments, 15.73%; equity-like products, 7.84%; mutual funds, derivatives and others, 3.06%.

And if you think this mix of assets looks too risky for liquid WMP products, you’re not alone. Bank of America:

“There are obviously considerable risks involved with non-standard debt instruments, equity-like and other products, which together accounted for 26.63% of total WMP assets, worth Rmb6.3tr. In addition, we do not consider credits, and to some extent, money market products are safe in China given, in our opinion, risk in the financial sector could be systemic. Given the implicit guarantee mentioned earlier, we suspect that a significant portion of the WMP related losses may migrate onto banks’ balance sheet if a liquidity shock occurs."

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