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Too big to fail? Debate engulfs fate of China's wealth product market

HONG KONG -- 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 US$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 branch near Shanghai, which failed to pay out on maturity late last month. The bank, a midsized lender partly owned by Deutsche Bank, 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 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.

The products are part of China's “shadow banking” system — or credit given to borrowers outside formal lending channels. Barclays estimates the shadow banking industry has nearly doubled in the past two years to 25.6 trillion yuan (US$4.11 trillion), or more than a third of total lending.

Beijing has not forced Hua Xia Bank to pay back the estimated 500 investors hit by the default.

China International Capital Corp. (CICC), a prominent Chinese investment bank, urged regulators in a Dec. 4 note to allow such products to fail. Most are not guaranteed by banks, analysts say.

“If we don't take this opportunity to let a relatively small-scale contract be broken, it will only reinforce the attitude that these products have a rigid return and a limitless guarantee,” CICC said. Forcing Hua Xia to stand behind these products would cause “no end of trouble,” it added.

In a sign of how sensitive the issue has become, the China Banking Regulatory Commission (CBRC) recently told reporters not to ask about Hua Xia. Reports by some Chinese media have been taken off their websites.

The CBRC confirmed a report on Wednesday in the Southern Metropolis Daily which said the regulator had sent an “urgent” notice to banks ordering them to check third-party financial products sold through their branches, mainly trusts, insurance and investment funds.

At the same time, state media have stepped up efforts to warn of the risks associated with certain wealth products.

The official China Securities Journal on Saturday warned investors about a product called “Good Voice,” an 800-million-yuan investment offering double-digit returns from music concerts. The same article mentioned one that invested in hams, launched last month by Jinzi Ham Co. Ltd., offering returns above 10 percent.

China's Version of the CDO

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