China’s Latest Bubble Is Its Most Serious Yet

The sheer size and ever-changing nature of Beijing’s asset-management industry make it near impossible to regulate

By Anjani Trivedi

China´s Asset Management Business

Chinese regulators are targeting the latest bubble in their financial system: the domestic asset-management industry. Unfortunately, it is a moving target.

The gargantuan industry—a byproduct of China’s trapped and churning capital—has more than doubled in size in the past two years and is now worth around 60 trillion yuan, or nearly $9 trillion. A closely knit network of financial institutions like banks, funds, trusts, brokers and insurance companies issue the bulk of the industry’s products.

The problem for Beijing isn’t just the industry’s sheer size. The evolving relationships between the key players and the ever-changing nature of the products they sell have made it nearly impossible to regulate. Even if the authorities manage to stamp out one area of egregious behavior, another quickly emerges.

Number of bank-issued wealth management products outstanding

Much of the problem stems from China’s banks, which have issued almost 30 trillion yuan of wealth-management products in the recent past, offering them as lucrative short-term investment opportunities to ordinary household and corporate customers who buy them in the belief that they have an implicit guarantee from the bank. By the end of the first quarter, some 44,000 of such products were outstanding, more than half of which were due to mature by the end of the second quarter, according to analysts at Autonomous Research. By contrast, western banks issued around 7,300 similarly complex products between 1998 and 2008, ahead of the global financial crisis.

These products, usually recorded off the banks’ balance sheets, ripple through the financial system in various ways that complicate regulators’ efforts. Banks looking to artificially improve their capital-adequacy ratios have sold some $3.7 trillion of their own loans into WMPs, Autonomous estimates.

Other smaller banks, looking for high-yielding assets, are among the customers for these WMPs, which also invest in assets like stocks, money-market funds, bonds and commodities, periodically fueling bubbles in those markets.

Further muddying the waters, banks can also package up some of their loans and sell them to nonbank financial institutions like mutual funds and trusts. These then parcel the loans into so-called asset-management products and plans, which they can sell back to the original banks and other institutions. Hey presto! A bank’s loan book has suddenly become part of the bank’s investment portfolio. Autonomous estimates banks have unloaded another $1.9 trillion of loans this way.

Together with the loans channeled into WMPs, that is an amount equivalent to half of China’s GDP stowed away into the shadows.

As banks find other new ways to channel these products, the network has come to include big insurers and brokerages, with such institutions often leveraging up to buy ever more products from each other, which only exacerbates the problem. The short-term nature of the products, when set against the long-term nature of the assets in which they often invest, creates the risk of asset-liability mismatches that could potentially destabilize Chinese markets if funding is squeezed.

Chinese regulators have now signaled their determination to quash the leverage in this system and untangle complex assets jointly issued by various financial institutions. The task looks herculean.

And as long as the financial system’s shape-shifting continues, any regulatory crackdown may just lead to the emergence of new immeasurable risks.

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