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Bank of China executive warns of shadow banking risks

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BEIJING, Oct 12 (Reuters) - A senior Chinese bankingexecutive has warned against the proliferation of off-bookwealth management products, comparing some to a Ponzi scheme ina rare official acknowledgement of the risks they pose to theChinese banking system.

China must "tackle" shadow banking, particularly the shortterm investment vehicles known as wealth management products,Xiao Gang, the chairman of the board of Bank of China, one of the top four state-owned banks, wrote in anop-ed in the English-language China Daily on Friday.

"Unsurprisingly, although Chinese banks' non-performingloans are at a low level of 0.9 percent, the potential risks areworse than the official data suggest," Xiao wrote, adding that aproblem could come as indebted borrowers face cash flow problemsor enter default, straining the banking system.

"The music may stop when investors lose confidence andreduce their buying or withdraw from WMPs," he said, referringto wealth management products.

He warned of a mismatch between short-term products and thelonger underlying projects they fund, adding that in some casesthe products are not tied to any specific project and that inothers new products may be issued to pay off maturing productsand avoid a liquidity squeeze.

"To some extent, this is fundamentally a Ponzi scheme."

Xiao's op-ed is in line with similar warnings issued byoutsiders, particularly the Fitch Ratings agency whose Chinabanking analyst Charlene Chu has long warned of a maturitymis-match and the threat to the Chinese banking system ofproducts with various terms and interest rates.

But it is rare for a senior Chinese official to acknowledgethe extent of the problem.

"It is uncommon to find wealth management products that failto clearly specify the underlying securitised assets," anofficial from the China Banking Regulatory Commission, whichoversees financial products, told Reuters in August in responseto a query on the underlying assets.

NEW FUNDING TOOL

Wealth management projects, which are technically off-book,have grown to account for about a fifth of all new financing inChina. They fund projects, such as property development orinfrastructure, that have trouble tapping normal loan channels.

Their growth has been spurred by credit curbs meant to reinin speculative property investment and by investors' desire forhigher yields than traditional bank deposits, which often offernegative real interest rates. More than 20,000 of such productsare in circulation, up from just a few hundred five years ago.

Although the products are technically more risky thandeposits, most investors believe they are backed by the banks'implicit guarantee and they are marketed aggressively in bankbranches nationwide. Xiao acknowledged this perception posed arisk for banks' bottom line.

"The rollover of a large share of WMPs could weigh heavilyon formal banks' reputations, because many investors firmlybelieve that banks won't close down and they can always gettheir money back," Xiao said.

In June, People's Bank of China vice governor Liu Shiyu saidmany banks are not transparent enough about the risks wealthmanagement products carry.

"China's shadow banking system is complex, with a close yetopaque relationship to the regular banking system and the realeconomy," Xiao concluded by saying.

"It must be tackled with care and sufficient flexibility,but it must be tackled nonetheless."

(Reporting By China Economics Team, Editing by Lucy Hornby andJacqueline Wong)

((lucy.hornby@thomsonreuters.com)(+86 10 6627 1269)(ReutersMessaging: lucy.hornby.thomsonreuters.com@reuters.net))

Keywords: CHINA BANKING/SHADOWLOANS