China’s Wealth Management Products, A Q&A

We’ve had a number of questions regarding the growth and the risks surrounding China’s Wealth Management Products (WMPs). Here is an overview in a Q&A format.

Q: What are the reasons for the continuing demand and proliferation of WMPs in China?

1. China’s bank deposit rates have been extremely low over the past decade and until recently have been artificially capped by the nation’s central bank, the PBoC. The reason for these low rates is Beijing’s effort to make sure that the banking system has access to cheap financing in order to stimulate credit growth.

Source: Tradingeconomics, PBoC

These days, awash with deposits, many banks pay even less than the latest rate set by the PBoC. Here is one example showing why China’s depositors have been desperate for yield.

Source: Bank of China (one of the 5 biggest state-owned commercial banks in China)

2. Another reason for the explosion in WMPs in China is the rapid growth in money supply, with limited options to deploy all the new cash. The chart below shows China’s  broad money supply (M2), now 15 times the size it was at the end of 1999. That’s a great deal of liquidity sloshing around.

3. More money poured into WMOs last year after the massive “correction” in China’s stock market, as investors looked for other sources of yield.

Q. What rates do banks offer to their WMP customers?
A. In 2015 the typical WMP product yield ranged between 4.5% and 5%.

Q. What is the typical WMP term?
A. According to HSBC, “more than 90% of China’s fixed duration WMPs are shorter than a year”.

Source: HSBC

Q. How do WMPs generate returns?
A. These days most are invested in corporate bonds although some also invest in private loans. The most popular type of bond in WMPs’ asset portfolios is a AA corporate (domestic agency ratings of course) with a 4-5 year maturity.

Q. What is the yield on such bonds currently and is it sufficient to pay the WMP rates?
A. Here is the RMB AA corporate yield curve. With a little help from leverage (usually via the repo market) and/or a big duration mismatch, WMPs generate the necessary yield.