Alarm bells are ringing as Chinese citizens keep pouring their savings into wealth-management products, a market that has tripled to more than $4 trillion in a little over three years. Like mortgage-backed securities were in the U.S., these products are building blocks of a shadow-banking system that exists largely off banks’ balance sheets. In China, a history of bailouts has persuaded many investors that WMPs are implicitly guaranteed by the issuing bank or the state. The People’s Bank of China has taken note, as have other regulators.

1. Why are WMPs so hot with investors?

Issued by banks, WMPs have emerged as a key tool for lenders to attract funds. Investors are lured by yields of 3 percent to 5 percent, compared with 1.5 percent for one-year bank deposits. The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep the WMPs off their balance sheets provided the products are not principal-guaranteed, which most are not. They can also hand over the products to non-banks to manage in return for a predetermined interest rate.

2. What are the risks for the financial system?

Banks may face a liquidity crunch if investors turn cold on the products, which mostly have terms of six months or less. Lenders use WMPs in some of the financial engineering that helps them to sidestep lending restrictions and capital requirements. WMPs have already invested in each other, meaning one soured product could infect others. And by ceding control of the products to brokerages and fund management firms, those institutions have created new layers of products investing in bonds and loans to risky investors.

3. So what are the authorities doing?

Financial regulators have banded together to impose rules for the entire asset management industry in April last year, which mandated all products must comply with new strictures by the end of 2020. These include removing implicit guarantees, capping leverage, reducing duration mismatch and increasing transparency on who actually issues and holds these products. Under separate rules on WMPs published in July, banks must set aside 10 percent of fees from managing WMPs to cover potential risks and are banned from selling products touting expected rate of returns or investing proceeds from WMPs into other WMPs.

4. How much money is involved?

The outstanding value of off-balance sheet WMPs stood at 22 trillion yuan ($3.3 trillion) at the end of 2018, official data showed -- that’s equivalent to 24 percent of China’s gross domestic product. Mid-tier banks such as China Merchants Bank and China Minsheng Banking Corp. are especially dependent on the products for funding and commission income.

5. What do experts and markets say?

Xiao Gang, former chairman of Bank of China Ltd., had warned of “Ponzi scheme” dangers for the WMPs in 2012. Bank of America Corp. strategists said in 2017 that “a liquidity crunch in China’s shadow banking sector over the next year or two is a genuine risk.” Banking analyst Charlene Chu said WMPs are defying market gravity. With the new rules taking full effect in 2020, Macquarie Research analyst Dexter Hsu said “the superior profitability of the WMP business is over.”

6. Is there anything else to worry about?

WMPs are the biggest component of China’s shadow-banking world that has increased risk in the financial system. As part of the two-year deleveraging campaign, banks were forced to bring some of their off-balance WMPs onto balance sheet by issuing so-called structured deposits to retain customers. Such moves threaten to hurt banks’ profitability and undermine their capital strength.

--With assistance from Steven Yang, Heng Xie and Zhang Dingmin.

To contact Bloomberg News staff for this story: Laurence Arnold in Washington at larnold4@bloomberg.net;Jun Luo in Shanghai at jluo6@bloomberg.net

To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, Grant Clark, Paul Panckhurst

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