Very little has been written about the regulation of Chinese shadow banking products, so we start here with a discussion of the regulation of banks’ wealth management products, since they have been so wildly popular in recent years. Wealth management products are products sold by banks that may be securitized off of bonds, stocks, loans, and other types of debt products. These products are normally sold to regular consumers, and may be of different (mainly short-term) maturities, interest rates, and risks. It is the consumer who bears the risks and loses her investment, should the wealth management product default.
These products became very popular in 2008 and thereafter, as growth in other areas of China’s economy slowed. Regulation through 2008 was relatively light; it began in September 2005 when the personal wealth management business was discussed by the China Banking Regulatory Commission (CBRC) for the first time. Certain types of wealth management businesses, such as that connected to guaranteed returns, required CBRC approval while other types did not. Risk management problems were required to be reported to the authorities. Overseas wealth management services were regulated and initiated in June 2006, and resulted in the generation of Qualified Domestic Institutional Investor (QDII) products, which were, as it turns out, not overly popular due to investment restrictions.
Starting 2009, regulation became somewhat more focused on risk control. Two notices were issued by the CBRC in 2009: the May notice stated that commercial banks should submit reports on wealth management products for approval ten days before the product is issued, in order to ensure the integrity of the products, while the July notice stated that funds received from sales of wealth management products could not be invested in the secondary markets (in securities-backed funds, equities, equities of unlisted companies, or untraded shares of listed companies), and that risk diversification and assessment must be put into place in the wealth management product business. Clients were supposed to be classified in terms of their investment experience, and higher priced wealth management products were to be sold only to those with experience (“experience” was to be determined by the bank).
Banks and trust companies had, until this time, been cooperating, so that banks could take loans off their books and repackage them, through trust companies, as wealth management products. An August 2010 notice indicated that the bank-trust wealth management cooperation business must not exceed 30 percent of all financing business, and that commercial banks must shift their off-balance sheet business to their balance sheets within one year and increase their provision coverage ratio. This notice had the effect of greatly reducing this extremely risky practice.
An August 2011 notice issued by the CBRC laid out specifics on information disclosure, requiring that banks produce documents that listed the risks associated with wealth management products and that consumer rights be clearly explained. The 2011 notice also said that deposits should not be tied with wealth management products, and that excessively high returns on the products were prohibited. In December 2012, banks were further warned that they should scrutinize third-party wealth management products, including insurance, trust and fund products, and submit their reports to the CBRC. By this period, banks were increasingly under review as two banks faced problems in the repayment of wealth management products. Simultaneously, sales of these products were still growing.
The March 2013 notice by the CBRC focused on reducing the holdings of non-standard debt assets (NSDAs), those that are not traded on interbank markets or securities exchanges, including trust and entrusted loans. Holdings of NSDAs were reduced to 35 percent of wealth management products and within 4 percent of total assets, as noted in the bank’s previous year audit report. The notice also required banks to meet tighter disclosure requirements and stricter internal controls requirements. Finally, a January 2014 circular based on a speech delivered by CBRC Vice Chairman Zhou Mubing stated that banks should clearly separate their wealth management business from the deposit business and make it clear that wealth management products are not risk-free.
Circular 107, issued in December 2013 by the State Council, required banks to separate funds of wealth management products and banks’ own funds, and also put regulation of wealth management products under the purview of the People’s Bank of China, but regulations based on this document were not drawn up thereafter. The document was to be used as a basis for preparing shadow banking regulations at the National People’s Congress in March this year. Instead, at this meeting, Premier Li Keqiang stated that he had set a timetable for regulating the shadow banking industry under the Basel III accord guidelines.
Further regulations will be closely monitored by analysts, particularly since China’s shadow banking system has become rather large and unwieldy, full of hidden risks. Expect coming rules regarding wealth management products to be even more specific as the possibility for product failures mounts.
Follow Sara Hsu on Twitter @SaraHsuChina.