Caixin | As we start 2016 hoping for a better economic outlook, regulators must address certain financial problems, particularly risks associated with wealth management products that led to many defaults last year. China weathered several major financial storms over the past decade because of a towering pile of savings that provide banks with ample liquidity to prop up the market during times of trouble. But now depositors are using their money to snap up financial products offered by trust companies promising high returns.
Financial innovation that has given rise to a wide range of wealth management products should be a good sign of a financial market maturing in a well-regulated way. The problem in China is that these schemes are fraught with risks due to a lack of oversight and transparency and a lack of self-discipline among trust companies.
Many firms selling these trust products via the Internet circumvent restrictions on non-bank lenders to operate in gray areas, exposing retail investors to great risks. Small investors who have rushed into high-yield products are not necessarily aware of the dangers they are exposing their savings to.
Much of this savings money is flowing into wealth management products usually sold at banks. But regulators have not put in place a system obliging banks and trust companies to control risks and be clear in their dealings. Many investors still believe that the government should provide the same guarantee for these products as it does for bank deposits, even though they are very different. And many still expect the government and banks, many of them government-backed, to jump in with a bailout when defaults occur. As a result, bankers and officials concerned about the stability of society often feel obliged to appease investors when problems arise.
All of this means that risks associated with the products are magnified because they are issued in great quantities when everyone involved sees bailouts as a guarantee.
Many non-bank financial institutions that used to sell these trust products in collaboration with banks for small commissions have instead become shadow banks seeking bigger profits. Their products often involve high-risk debts held by manufacturers in industries beset by overcapacity, something investors are completely unaware of. Any fall in the prices of these securitized assets is likely to trigger a domino effect of defaults.
The problem is complicated by the fact that the current system of oversight involves the central bank and the commissions supervising commercial banking, securities and insurance industries. Under this oversight structure, regulators are more interested in protecting their turf than investors. When a crisis occurs, they tend to point the finger of blame at other parties.
Effective oversight will require regulators to have the right tool box. One indispensable tool is an information disclosure mechanism that allows the government to assess the risks that come with certain products and to limit their availability. A system such as this would keep investors more informed. To that end, regulators should set up a unified database that provides details on all financial companies selling wealth management products and where the proceeds of those products wind up.
The top leadership took steps in the right direction by laying out a strategy for developing an integrated regime for financial oversight at a meeting of the Communist Party’s Central Committee in October. Now the government must demonstrate wisdom and resolve to push to make the strategy a reality before it is too late.
Regulators should have a clear mission and commitment. Effective oversight depends upon whether they have the legal protection to operate independently and the expertise to get the job done. These are the hard lessons we learned from financial crises the world over.
On top of this, authorities should also stop letting themselves be held hostage to the shadow banking system. If the government continues bailing out irresponsible trust companies when defaults occur, the situation will never improve.
The rapid growth of wealth management products coupled with insufficient oversight of high-yield, high-risk investments has put the country’s small investors at risk. It is early 2016, and the warning bells are ringing. The question is whether the authorities will heed them.