Chinese Bank Stocks Dumped on Tighter Regulations

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China's financial stocks slumped on Thursday after Beijing's banking regulator unveiled new restrictions on wealth management products (WMPs) on Wednesday in order to reduce risk taking.

The China Banking Regulatory Commission released a statement ordering lenders to set up greater transparency controls for each financial instrument sold. Banks will now have to keep an accounting book for each instrument to monitor all actions.

The news sparked a sell-off in the sector, with Industrial Bank plunging 10 percent, China Minsheng Bank tumbling 9 percent and Anxin Trust easing over 7 percent.

"While we feel this is clearly negative for the local banks; for other asset classes these measures represent a prudent and disciplined approach to what is clearly a growing problem for the Chinese," said Chris Weston of IG Markets in a research note.

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The negative sentiment triggered a 2.8 percent fall in the broader Shanghai Composite and spilled over to Hong Kong, causing a 0.8 percent slide in the benchmark Hang Seng Index.

WMPs, which span from trust loans to letters of credit, constitute a large part of bank balance sheets, and as much as half of all new deposit growth is generated through this medium.

In December, Fitch Ratings Agency released a report stating that "WMPs present growing risks for the sector as larger amounts of funding are sourced through this channel." The report further detailed how Chinese banks were issuing the equivalent of 100 new WMPs per day in the third quarter of 2012.

While the public considers these assets a safe alternative to bank deposits, in reality, lenders are not responsible for the performance of these products. Failure of banks to pay out returns could lead to overall defaults.

"Much of the money invested in these high-yielding products is being utilized to fund high risk loans, with SMEs (small to medium sized enterprises) expressing strong demand, and it's this demand that creates both an explosion in credit and real systematic risks," Weston continued.

Given the high-risk and high-yield nature of these short-term investments, Beijing is using these transparency measures to crack down on risk.

Analysts say the reason lenders are reacting so strongly to these new transparency controls is because WMPs are a surefire source of profits, especially in China's volatile banking environment.

"The overall guidance for this year's prospects is not that good. In general, all the bank chiefs expect another tough year, though it may not be as tough as FY12," said Ivan Li, Deputy Head of Hong Kong Research at Kim Eng Securities.

Lenders are currently facing several headwinds for 2013, including a reduction in transaction fees, interest rate liberalization and an increasing amount of bad debt.