China’s Banks Dance with New Risks

“Joyful Dance With Stocks,” “Wisdom & Reward,” “House Filled With Riches” — those are just some of the enticing names Chinese lenders are giving new products they hope will lure savers, as competition for deposits intensifies amid the crackdown on “shadow banking.”

The end of the wealth management gravy train, flagged last year by financial regulators and finally introduced in April, has forced banks to turn to new ways of attracting deposits that also offer potentially higher returns than plain-vanilla savings accounts while also guaranteeing the investor’s original capital.

One of the most popular alternatives has been structured deposits, a savings product that is linked to the performance of some kind of investment or derivative, such as a stock or commodities index, a domestic interest rate such as Shibor, or the exchange rate. The principal is guaranteed, and while banks aren’t allowed to offer a fixed return, they provide savers with a range of investment options with the potential to bring higher returns depending on the risks involved. 

“Joyful Dance With Stocks,” a one-year deposit linked to stock performance with a potential return of as much as 7%, is being sold by China Guangfa Bank, while “Wisdom & Reward,” linked to the CSI 300 Index, is being offered by Huaxia Bank with a potential annualized return of 2% to 8.25%. These compare with an interest rate of below 2% on a one-year time deposit. “House Filled With Riches,” also from Guangfa Bank, is linked to prices of agricultural products.

Regulators on alert

But structured deposits are now appearing on the radar screen of regulators as they risk running afoul of new asset management rules that prohibit financial institutions from offering implicit guarantees on the principal and returns on all asset management products. Financial News, a newspaper owned by China’s central bank, reported (link in Chinese) on May 21 that some local financial regulators have already started to restrict the issue of structured deposits by smaller lenders, adding that more detailed regulations on the instruments are likely to be imposed due to the significant growth in sales. 

At the end of April, the outstanding amount of structured deposits issued by commercial lenders was 9.15 trillion yuan ($1.43 trillion), a surge of 50.8% from a year earlier, according to central bank data released last week, up from a growth rate of 46.7% in the first quarter.

Banks issued 1.84 trillion yuan of such products in the first quarter, already surpassing 2017’s full-year issuance of 1.8 trillion yuan. New issuance rose by a further 360 billion yuan in April, the data show.

Traditionally, institutions have been the biggest buyers of structured deposits and remain the largest holders, at 5.29 trillion yuan of the total. But individual investors have been pouring money into these products — central bank data show that outstanding structured deposits held by individuals jumped by 75.2% in the year through April to 3.86 trillion yuan, compared with an increase of only 36.9% for institutions.

Although banks are pitching structured deposits as safe products with good returns, some are in reality not linked with derivatives, while others promise unrealistic yields, Caixin has learned. Under pressure to lure funds from customers who care more about yields than the actual performance of the underlying investments, some banks have been giving implicit guarantees for the return of structured deposits, banking sources said.

“Customers who buy structured deposits from banks are usually big clients who are more sensitive to the fluctuation in yields,” said Wu Wen, a senior analyst at the research center of Bank of Communications. “In order to keep these customers and stop them going elsewhere, some banks are issuing ‘pseudo-structured deposits.’ But these fake structured products are just perpetuating the implicit guarantee” that regulators want to break, she said.

Moral hazard

“The problem with these products, structured deposits or the wealth management products is that there tends to be a high level of implicit guarantee associated with them,” said Grace Wu, head of China banks ratings at Fitch Ratings. “That’s where the issue is because in a way the deposits are benefiting from the high yields, but (banks) are not setting money aside for risks (of losses). … We really need to break the moral hazard and require more recognized losses on these products.”

Structured deposits may just be a short-term solution for banks, as cleaning up their wealth management business and gradually bringing their off-balance sheet wealth management products back onto their books will be a lengthy process. These products are also too expensive for banks as a way to attract deposits, so they are unlikely to be a long-term alternative, according to Sophie Jiang head of Hong Kong and China banks equity research at Nomura Holdings Inc.

“We can see this as a temporary method to cushion the impact of asset management rules, but not the ultimate solution because structured deposits are very expensive,” she said. “Our understanding is that structured deposit rates are generally about 4%, and the one-year bank deposit rate is only 1.5%, there’s huge gap here. … So we don’t think this structured deposit is going to be the funding channel of banks in the long term.”

Cost was also an issue highlighted by Moody’s Investors Service in its May 16 report on China’s shadow-banking industry, or those activities that aren’t on financial institutions’ balance sheets and have escaped regulatory oversight. It said that the shift toward structured deposits could put more pressure on smaller banks’ profitability as the strong growth in structured deposits would come at the expense of weaker growth in cheaper funding sources such as demand deposits.

The lack of regulation on structured deposits is creating confusion in the market about what is and isn’t allowed and where these products fit into the new regulatory framework. Citic Securities Co. analysts pointed out in a recent report that a distinction between a bank’s wealth management products and structured deposit products needs to be made clear in accounting and other supervisory rules.

They called for financial authorities to issue detailed rules so that banks have clarity and can undertake compliance work on issues such as the classification of structured deposits, supervision measures, data submission, sales processes and information disclosure, the report said.

Contact reporter Leng Cheng (chengleng@caixin.com)