China structured deposits falter after shadow banking climbdown

Easing of restrictions on wealth management products tips market away from structured deposits

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A surge in Chinese structured deposits, a savings account with enhanced returns, has fizzled out in less than a year, as Beijing relaxes restrictions on competing wealth management products.

Structured deposit volumes fell in October by 237 billion yuan ($35 billion) from the previous month, according to recent data from the People’s Bank of China. The market’s first significant fall of 2018 comes after a 65% growth in such products in the first nine months of the year to 9.9 trillion yuan.

“The last three or four months have seen a slowdown in structured deposit volumes,” says one senior structurer at a Chinese bank. “We were experiencing fairly consistent growth, but now growth is close to zero or even negative.”

Structured deposits combine the features of regular time deposits with a higher-yielding investment element. Banks use the product as a reliable funding source for corporate loans, which they previously funded partly with wealth management products.

The Chinese authorities clamped down on wealth management products at the end of 2017, amid fears that banks were using too many of these assets for illiquid loans held off-balance sheet, which offered investors little protection against default. The restrictions were part of a crackdown on unregulated shadow banking activity.

But the central bank watered down the measures last July, allowing financial institutions to continue issuing existing products for investing in new assets during the transition period, which concludes at the end of 2020.

“The authorities in China realised that over-tightening the regulation led to a large and undesirable slowdown in economic growth. As a result, some aspects of the transition to the new asset management rules have been relaxed,” says Shengzhe Wang, a lawyer at Hogan Lovells in Shanghai. “I am quite sure that if economic growth continues to slow down, then the implementation of the wealth management product restrictions will be further relaxed or delayed.”

In a further boost to the instrument, the main banking regulator, the China Banking and Insurance Regulatory Commission (CBIRC), announced in October that publicly sold wealth management products would be able to invest directly in the equity market for the first time.

The rule change follows a small rebound in off-balance sheet wealth management products, with outstanding issuances increasing from 21 trillion yuan at the end of June to 22.3 trillion yuan at the end of August. This represents an increase as a proportion of total bank assets from 8.3% to 8.7%, according to rating agency Moody’s.

Despite the relaxation of the rules, some firms are struggling to adapt to the new regime. In December, the CBIRC hit six banks with total fines of more than 150 million yuan for breaching regulations on wealth management products. But several banking sources say authorities are prepared to take a more lenient tack for organisations labouring under the new rules.

For example, banks are required to value the net worth of their product set, based on market rates rather than internal estimates. But in situations where market data is considered weak or insufficient, banks can continue to base their product valuation on their own calculations for the time being while they prepare for a more market-based approach – a move that sources say will support activity in certain high-return guaranteed products.

“The government wants to control the volume of off-balance sheet wealth management products, but they can’t just shut down these products totally,” says the senior structurer. “They need to maintain the volume to make sure there are no further systemic risks in the market.”

In response to a slowing economy, China’s authorities have pumped more liquidity into the financial system. The extra liquidity has put downward pressure on the market funding rate – an interbank measure of how much banks earn for lending out funds. This, in turn, has hit the rates that banks can offer on structured deposits. At the start of 2018, structured products houses were able to offer returns well in excess of 5%, but few can now offer returns of more than 4.6%. This is still a healthy premium over the central bank’s policy rate of 2.55%, though.

The question is if people are not investing in structured deposits where else would they go?
Charles Gu, Societe Generale

This decline in returns is thought to have contributed to the fall in structured deposit volumes at the end of last year, leaving investors with limited alternative options.

“The question is if people are not investing in structured deposits where else would they go?” says Charles Gu, head of China sales at Societe Generale, based in Shanghai. “One alternative would be bank deposits, but the yield would be much lower than a structured deposit with a low-value option. Another alternative would be money market funds, but these are highly correlated to the market funding level as well.”

Equity markets have provided little succour for investors over the past 12 months. The nation’s Shanghai composite stock index lost nearly a quarter of its value during 2018 as a trade war with the US weighed on the economy and crimped corporate earnings. The index has continued to trend lower in 2019.

Despite the recent decline in structured product volumes, few believe it is a lasting trend and instead predict an upswing in volumes over the next year or two.

After the surge in structured products at the start of last year, some banks may feel they do not need to push them as aggressively, since they already have significant levels of issuance on their balance sheet.

“Banks are likely to want to maintain healthy volumes [of structured products],” the senior structurer says. “We are comfortable with our decline in structured products this year [2018], given that they already account for a greater portion of our balance sheet than at other banks.”

The structurer adds that sales commissions tend to be greater for wealth management products than for structured products. Sales teams aiming to boost their end-of-year earnings may have prioritised wealth management sales, contributing to the decline in structured products.

For banks wanting to improve their liquidity position, structured deposits are an effective tool, which is why some think they will eventually make a comeback. Wealth management products would not count towards the bank’s own funding, because they are off-balance sheet.

A sales director at a global bank says: “Most of the banks – outside of the Big Four – that are interested in having stable liquidity to support their balance sheet have few choices other than to issue those kinds of structured products with low-value options.”

The director adds that if banks offer normal deposit rates, they will fail to attract sufficient volumes of business from depositors, which will undermine their balance sheet and raise the risk of a liquidity crunch.

Correction, January 23, 2018: A reference in this article has been changed to clarify that the structured products market activity took place in 2018, not 2019.

Editing by Alex Krohn

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