Call it the great wealth rollover of China.
The nation's banks have been introducing new wealth management investment products at a blurring pace over the past year, dazzling upper-class clients with fat catalogues of high-yield investment opportunities.
Yet Caixin has learned from bank and regulatory sources that much of the wealthy investor cash pouring into short-term, high-risk products is being rolled over by banks to provide fresh financing for long-term investments, including unfinished property developments, local government financing platforms, railway projects and private equity.
The rollover game is providing badly needed funds for infrastructure projects for which credit has dried up over the past year with every notch of monetary tightening by the central government. It's helped offset the government's rising bank deposit reserve requirement, for example, which has crimped bank lending.
At the same time, some industry experts warn, the banks may be fobbing off long-term investment risks to their wealth management clients.
By offering the well-to-do a dizzying variety of investment products along with promises of near-double-digit returns, some fear banks are leading wealth management clients into the same trap that caught U.S. investors before they were fleeced during the 2007 subprime mortgage crisis.
About 9,000 types of wealth management products were available to Chinese investors during the first half of 2011, double the number offered in 2010. Capital turnover for these products topped 8 trillion yuan between January and June.
One risk management executive at a commercial bank told Caixin that wealth management product risks in China are far lower than those faced by subprime mortgage investors in the United States. But others say Chinese products are often too good to be true.
"Some products are expected to yield close to 10 percent," said one bank executive. "But how are banks getting access to so many high-return investment channels?"
China's banking regulators have taken note of the rollover game and are trying to reign in risk and prevent a potential wealth management meltdown. But the players are already firmly entrenched.
Some bank critics say wealth management products have been used to build a shadow banking system beyond regulatory reach. Others warn of possible Ponzi schemes, or call the race among banks for wealthy clients maddening.
Some banks, critics contend, slyly use funds raised by selling short-term, high-yield investment products to fill financial holes as soon as they appear – and before these holes show up on accounting books.
Banks used to invest wealth management funds in the bond market. But over the past year they've branched into private equity, transportation infrastructure and real estate.
"A lot of wealth management funds are invested in infrastructure fields like real estate and highways," a joint-stock bank executive told Caixin. "As to how much is invested and to what extent risks are accumulated, banks can't see the complete picture.
Sources say banks have become an increasingly important fund-raising channel for private equity funds including CDH Investments, DT Capital and SAIF Partners. In addition, said a banking source, many banks are financing private equity teams of their own.
For example, China Construction Bank and several partner institutions now run a number of industrial fund management companies.
CCB branch offices collect information from loan customers with deposits accounts. The data is then offered to CCB private equity fund managers, who then pick and choose favorites for investing.
CCB's clients include the Yunnan Highway Development Investment Co., a provincial government-affiliated platform for financing road projects, that borrowed billions of yuan. The bank provided loans by selling some 4 billion yuan worth of wealth management financial products to its clients. The platform was close to default early this year.
"Branches understand the situations clients are in," said an investment banker. "Equity investment can better grasp invested companies through banks, and that's also the tendency among lenders."
The upside is that "this sort of combining equity and loans has increased bank competitiveness" by preventing customer turnover yet diversifying business, the banker said.
But a private equity source warned that the system poses risks for the banks that double-up as a customer lender and equity holder. And when the investment involves cash raised through wealth-management products, the risks are stacked even higher.
Some experts warn that this shadow banking system may evolve into a dangerous Ponzi scheme that could collapse at any time, burying wealth management investors along with the banks.
"If wealth management products continue to go crazy, they will evolve into ponzi scheme," said a private equity strategist. "If real estate goes bad, bank financial products will meet with disaster too."
A Bank of China finance manager China told Caixin that wealth management clients can choose from short-term, fixed-income (guaranteed principal and profit) products; non-fixed-income, collective financial products; and high-risk, high-yield and variable rate trust products for investments of at least 1 million yuan.
Interest rates are especially high for products sold toward the end of each month or quarter, the banker said.
A source at a joint-stock bank said capital from a bank's short-term wealth management product goes into a capital pool. The pool's size is maintained by continuously rolling through new products. And an ever-increasing share is steered into high-yield, risky assets, the source said.
A China Banking Regulatory Commission (CBRC) official said this "capital pool method is not consistent" with the regulator's basic "principles" of separate and transparent accounting for wealth management plans.
Rules likewise say Chinese banks cannot invest in mainland private equity funds. But they get around the barrier by working through Hong Kong, said a source at a major, state-owned bank.
"And while growing wealth management funds cannot be invested in PE, they can be invested in trust products," the source said. "Targets for trust products can be all-inclusive, and returns can be higher than that for unlisted equity, land and other targets."
A CBRC official said some banks structured wealth products in ways designed to avoid their own risk control departments. Wealth management research, design, sales and even after-sales service may be handled without risk supervision in some cases.
Thus, managing the wealth product arena has strained nerves among bankers and regulators alike.
On July 1, for example, an argument erupted at a meeting of bank executives called by a local bank oversight bureau in an eastern city. Tension was in the air because the executives had worked all night preparing documents for a discussion about the competition for wealthy client deposits.
As the discussion turned to shouting, meeting participants accused each other of recklessly issuing wealth management products and offering ever-higher interest rates merely to win rich customers.
This friction pointed to, on the positive side, market-oriented pricing for financial products and healthy competition. Industry insiders say the system is giving the banking industry a preview of the playing field that would emerge if deposit interest rates are marketized in China.
But the stress was serious. Indeed, similar shouting matches have been seen in recent months at bank meetings in cities around China.
Banks in general are scrambling to attract depositors, and the wealthier the better. Job performance evaluations are often tied to deposit growth. So bankers and bank staffers have strong incentive to attract new clients by offering high-yielding wealth products.
Sometimes, earnings from these products add little or nothing to a bank's bottom line.
"Investment projects for many wealth management products are not necessarily profitable," said Zhang Yuanzhong, a lawyer with the Beijing Yiming firm, who specializes in financial disputes. "Many operate at a loss or break even.
"So this sort of rolling method, with new issuances used to repay old, is a massive game."
And a bank branch president told Caixin that innovative financial products have become more popular as bank staffers react to the pressure to pull in more deposits.
The shouting matches and fuzzy accounting prompted CBRC to announce in June a new requirement that banks clearly state on "all future product promotional materials, including in-bank display screens" that wealth management products "are not deposits. Products have risks, and investment must be cautious."
At a June 29 briefing, CBRC innovation business official Su Xinming said banks may not sell high-risk products to clients with low tolerance for risk.
The new rules, however, have not quenched bankers' thirst for capital nor slowed the rollovers of wealth management investments.
Indeed, a branch president for a major eastern province bank told Caixin that offering rolling, short-term wealth management products is now a standard means of attracting high-end client deposits.
More banks are moving toward short-term, high-yield products. Market analyst Wind Information said annual yields of more than 5 percent were expected for 91 of the 265 financial products issued by banks during the last 10 days of June. Five products were expected to top 7 percent.
The rolling nature of the investment money can be seen clearly by comparing the wealth product "flow" and "outstanding" values.
At the end of the first quarter, CBRC said, the total value of all outstanding wealth management products – all yet-to-mature products at any one time – was 1.9 trillion yuan. That's equivalent to about 2 percent of total commercial bank assets in China.
But the flow – total capital turnover during a given period – was 8.25 trillion yuan during the first six months of the year, up from 7.05 trillion yuan for all of 2010, according to the firm Benefit Wealth.
These figures are significant because "the key to knowing whether risk is imminent is to look at whether there are problems in the funding chain, and in which segment the problems occur first," explained Wang Jiwu, deputy director of the Financial Products Center at the Chinese Academy of Social Sciences.
One CBRC official said regulators rate financial products according to "calculable cost, controllable risk, adequate disclosure." But Zhang, the lawyer, said current wealth management product regulations are weak and systemic risks are building.
Last year, CBRC began requiring banks to include guaranteed-principal financial products on balance sheets, citing risk weights and capital adequacy ratios. The regulator also ordered a halt to joint bank-trust wealth management products.
Further tightening may come soon. CBRC started gathering public opinion in July on proposed standards for banks that sell wealth management products. The draft emphasizes making "the seller responsible" for investments. The regulator also wants banks to match products and investors according to risk levels.