TRUSTING investors can easily be gulled by scams designed to
relieve them of their savings. In China efforts to educate the unwary extend to
the streets. Walls are daubed with murals illustrating the dangers of Ponzi
schemes, which pay off early investors with money raised from a larger group of
later ones. In one cartoon a swindler, hugging a big pot of cash, sits atop a
human pyramid, representing the Ponzi principle at work.
The Ponzi principle has even tempted some of China’s banks,
according to a widely cited article in China Daily, an official
newspaper. The article was notable because its author, Xiao Gang, is chairman
of one of China’s four big banks and may take over the central bank later in
2013. Mr Xiao is worried about the proliferation of wealth-management products
(WMPs), which collect money from investors for a fixed term (usually less than
six months) and plough it into a variety of financial assets, from short-term
bills to long-gestation property projects.
Some of these products are issued by banks, although only a
minority are explicitly guaranteed by them. Others are merely sold through the
banks, which act as a distribution network. Mr Xiao frets that short-term
products are financing long-term projects, creating a maturity mismatch. He
also worries that some failed ventures are able to repay their bank loans only
by raising fresh funds through WMPs, a form of Ponzi finance.
It is hard to count, or even define, WMPs. They probably
topped 12 trillion yuan ($1.9 trillion) by the end of 2012, equivalent to about
16% of commercial-bank deposits, according to Charlene Chu of Fitch Ratings.
But that figure counts only the products issued by banks, which typically offer
pedestrian returns of about 4% on average. It does not include investments like
the 160m-yuan product issued by Zhongding Wealth Investment Centre, which
promised returns of 11-13%, according to Reuters, from investments in car
dealers, a TV production firm and a pawn shop.
This now infamous product was sold to customers at Hua Xia
bank in Shanghai by one of the bank’s employees. But the bank does not consider
itself liable for its failure, as hundreds of aggrieved investors discovered
when the product defaulted at the end of November. Unnerved by the Hua Xia
case, China’s banking regulator has told banks to carry out urgent internal
checks of all the third-party products they are peddling.
China has both a surplus of saving (almost half of GDP in
2012) and a shortage of suitable vehicles for that thrift. The bond market is
small, especially for retail investors, and the stockmarket is suspect, thanks
to shaky auditing and rampant insider trading. Property remains popular, but
the government has tried to curb speculative home purchases. For many, bank
deposits remain the default option. But they earn a meagre rate of interest,
capped by the government.
Given these alternatives, it is easy to explain why
investors are flocking to WMPs. It is harder to explain why the government
tolerates them. Why does it impose a ceiling on deposit rates, even as it
allows banks to issue close substitutes at whatever yield they can get? Why
retain a regulation, then let banks work around it?
It appears paradoxical. But this approach to financial
reform is in keeping with China’s approach to all economic liberalisation. It
reforms piecemeal, crossing the river by feeling for the stones, as Deng
Xiaoping, its former leader, put it. After 1978, for example, it kept many of
the central plan’s existing quotas in place. But it also allowed farms and then
firms to sell anything extra at whatever the market would bear. Rather than
throwing out the plan, China grew out of it, as Barry Naughton of the
University of California, San Diego, has put it.
Some analysts hope that WMPs will help China’s banks to grow
out of the country’s financial plan, forcing them to compete for custom among
choosy investors who will happily defect to a rival bank offering better terms.
Through WMPs, lenders can dip their toes into competitive banking, just as
farms and firms in the 1980s embraced the market even as they continued to
fulfil their duties under the plan. But this approach works only if the
government can continue to enforce its quotas and price controls. In the case
of banking, this is a difficult trick to pull off. The government can control
the price of deposits but it cannot control the quantity that firms and
households are willing to provide. The rapid growth of WMPs suggests that
depositors are switching to these products in increasing numbers. “China’s
previously sticky deposits are losing their adhesiveness,” notes Ms Chu.
Mural hazard
The problem is that the state may still have to pick up the
tab if things go wrong. Although only 15-20% of the WMPs issued by banks are
explicitly guaranteed by them, in practice banks would probably stand behind
their own products. (Third-party products sold through banks are a different
matter.) In pushing their WMPs, banks are trading on their own credibility. But
this credibility is not theirs to sell. It is borrowed from the state.
China’s government has closed only one bank in the past 15
years. And deposits enjoy an implicit state guarantee. Until recently, Chinese
banks enjoyed this state protection at the cost of limited freedom. The
introduction of WMPs has granted banks more freedom without any obvious loss of
protection. Because the state’s deposit guarantee is not explicitly stated it
is not explicitly limited either. Many WMP-buyers probably take comfort from
it. They might rethink if China introduced formal deposit insurance, limited in
scope and financed by the banks themselves.
In the meantime, third-party products like the one sold in
Hua Xia bank must be allowed to fail. The loss would provide a striking
illustration of the risks of financial speculation, painting a picture even
China’s muralists would struggle to match.
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