BEIJING/SHANGHAI -- Chinese regulators are moving to tighten controls on the murky parallel finance sector that channels money into high-risk investments, but some speculate that the rules could be loosened again if they bite too hard.
This effort to rein in the country's shadow banking sector, which poses a growing risk to the financial system's stability in the world's second-largest economy, has begun by casting a broad net of regulation over so-called wealth management products. Banks and other issuers sell these to individuals and corporations to raise funds for off-balance-sheet investments.
Some 29 trillion yuan ($4.39 trillion) worth of WMPs were outstanding as of the end of 2016, with 80% kept off issuers' books. Some of this money has flowed into local-government infrastructure projects and real estate development, providing a source of financing that escapes regulators scrutiny.
This month, the People's Bank of China moved in earnest to regulate WMPs. The central bank issued draft guidelines that define WMPs, trust products and the like as asset management products -- an umbrella term covering some 96 trillion yuan worth of investment vehicles. Asset management products will be subdivided for regulation into categories based on such characteristics as the types of assets they target.
This marks one standout feature of the new regulatory push. Existing regulations on financial products are applied based on the issuer -- an approach that reflects China's separate regulators for the banking, securities and insurance industries. Similar products are thus regulated differently depending on whether the issuer is a bank or insurer. This has encouraged a game of whack-a-mole between issuers and regulators, which would tighten controls on one industry only to see activity pick up in another.
Another key feature targets the implicit guarantee that WMPs enjoy. Although most of these products lack guaranteed rates of return, customers often assume an assurance of security in buying them from state-owned banks. The new regulations punish banks from dipping into their own capital to cover losses on WMP investments.
The rules are supposed to take effect in July 2019. The long wait attests to the major impact expected.
The draft rules appear to have been completed in early spring, but probably were held back until after last month's twice-a-decade Communist Party National Congress, which decided China's top leadership for the next five years. General Secretary and President Xi Jinping emerged from the congress with an even firmer grip on power.
If they go into force, the regulations on WMPs could crimp weaker regional banks and small and midsize lenders' ability to raise funds. Such institutions have dangled the promise of high returns to attract capital. If deprived of this draw, they probably will have to offer higher interest rates on deposits. This could put upward pressure on deposit rates at big banks, too, straining lenders' profit margins.
Out of the shadows
Banks are also thought to use WMPs to roll over debt to troubled borrowers. Curbing WMP sales could thus expose hidden non-performing loans, making it harder to raise capital for local infrastructure projects and real estate development.
Financial markets are showing signs of concern over these risks. The Shanghai Composite Index plunged more than 2% Thursday, nearly erasing its gains since October. Investors seem to worry that a decrease in WMP issuance could reduce the flows that these products send into the stock market.
Meanwhile, the yield on 10-year Chinese government bonds has risen sharply in November, topping 4% for the first time since October 2014. If tighter regulations squeezes banks' fund flows, "there could be some localized moves to dump sovereign debt," said a trader at a Shanghai bank.
Given this potential for turbulence, some doubt that the new regulations will be enforced. In 2013, China's banking authority banned issuers from pooling funds raised through WMPs, but that rule has been ignored. If the latest clampdown on shadow banking proves too destabilizing to the financial markets, Beijing may even undermine its own efforts in order to prevent the social unrest that it fears.