Analysis: Too big to fail? China's wealth management products stir debate

Wed Dec 19, 2012 4:04pm EST
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By Michael Flaherty and Kelvin Soh

HONG KONG (Reuters) - The default of a Chinese investment plan has handed Beijing a tough choice: bail out investors and endorse moral hazard or let it fail and risk unnerving those who hold at least $1 trillion in so-called wealth management products.

China's bank regulators are debating what to do about the investment sold at a Hua Xia Bank (600015.SS: Quote) branch near Shanghai, which failed to pay out on maturity late last month. The bank, a mid-sized lender partly owned by Deutsche Bank (DBKGn.DE: Quote), says a Jiading district branch employee sold the product without authorization.

Angry investors protested outside the branch for a week. That marked the first time - since warnings earlier this year from regulators and even one top bank executive who said some Chinese wealth management products were akin to a Ponzi scheme - that a failed product grabbed national media attention.

It's not yet clear how many, and to what extent, others have defaulted. But analysts say that if more flop and generate headlines like the Hua Xia case, a crisis in confidence could ensue, sparking a run on the wealth product market.

"Some of these products won't be able to generate enough money to pay back investors," said BofA-Merrill Lynch (BAC.N: Quote) China strategist David Cui. "The issue is, at a certain point, if it gets to a certain scale, you can no longer cover up the losses. Then we may have a systematic risk on our hands."

Wealth management products have taken off in the past five years, with Chinese looking for investment choices other than real estate, betting on the country's roller-coaster stock markets or parking money in bank accounts that offer state-set deposit rates.

The majority of the products are short-term savings vehicles often created by third parties and issued through banks. The products mostly invest in stocks and money market instruments, promising returns of 4-5 percent.

But a sizeable amount have funneled money into riskier investments, offering double-digit gains by financing anything from property and infrastructure projects, to car dealerships, pop concerts and even the sale of ham.   Continued...

Locals walk past a Huaxia Bank in Shanghai, December 12, 2012. Picture taken December 12, 2012. REUTERS/Aly Song