China debt draws comparison to US financial crisis

Wealth-management
products could shock China’s financial system.
Reuters

• Wealth-management products are collections of financial
  instruments sold as one high-yield investment.
• They may pose risks similar to those of mortgage-backed
  securities in the US leading up to the financial crisis,
  according to analysts. 

A trade
war may not be China’s biggest problem.

Analysts are cautioning against the country’s use of
wealth-management products, or groups of financial instruments
that are sold as one high-yield investment. Takahide Kiuchi, an
economist at Nomura, thinks they may even pose risks that mirror
those that led up to the Great Recession.

“The situation revolving around these [wealth-management
products] is similar to the residential mortgage-backed
securities problem in the US that eventually triggered the
collapse of Lehman Brothers and the global financial crisis,”
Kiuchi said.  

Kiuchi is referring to 2008 when mortgage-backed securities,
financial instruments that bundled risky home loans for
investors,
threw the world into years of economic turmoil.

Wealth-management products offer implicit or explicit guarantees
from Chinese banks, which are exposed to them through investment
companies. The outstanding amount of non-guaranteed bank
wealth-management products was more than $3 trillion at the end
of June, according to Reuters, and about 15% of that appears to
be invested in shadow lending. 

Kiuchi said any sudden removal of bank guarantees on these
instruments would likely lead to individuals pulling their funds
out. That could cause the collapse of the investment companies
that issue the wealth management products, he said, and
subsequently hit small and midsized banks and insurance
companies.

China’s financial authorities have been taking steps to address
these risks. Last month, the China Banking and Insurance
Regulatory Commission rolled out new regulations and guidelines
on wealth management products. 

But with an ongoing trade war between the US and China, Beijing
appears to be shifting gears. Kiuchi said officials seem to be
placing more emphasis on economic stimulus and less on structural
reforms and financial stability.

“A change in the environment could suddenly turn risks into real
problems,” Kiuchi said. “The authorities are walking a tightrope
in their efforts to carefully unwind these complex and tightly
intertwined financial risks.”

Others see financial system risks as more manageable. While UBS
strategists led by Adrian Zuercher acknowledged in a recent note
that some investors are concerned China could face a
financial crisis under the debt buildup, they don’t think it’s
likely. 

A majority of debt is domestic and funded by stable sources, they
noted. And much of that credit has been used for investment
rather than consumption, which they said makes additional
restructuring options possible.

“Still, the rapid rise in debt-to-GDP ratio reflects that China
has borrowed a lot from the future,” Zuercher wrote. “Another
issue in China’s credit market is the lack of credit
differentiation and prevalent implicit guarantees in investment
products.”