Wealth Management Products in the Context of China's Shadow Banking: Systemic Risks, Consumer Protection and Regulatory Instruments

By Wei, Shen | Asia Pacific Law Review, January 1, 2015 | Go to article overview

Wealth Management Products in the Context of China's Shadow Banking: Systemic Risks, Consumer Protection and Regulatory Instruments


Wei, Shen, Asia Pacific Law Review


I. Introduction

Shadow banking in China refers to lending that is not subject to banking regulations, and includes banks' off-balance-sheet vehicles such as commercial bills, entrusted loans, underground lending as well as wealth management products ('WMPs').1 Trusts and securities brokerages emerged as new conduits for shadow lending.2 As credit limits are rigidly enforced in China, part of China's domestic deposits was steered from bank loans and savings into opaque, off-balance sheet, risk-laden vehicles or underground financial networks. Meanwhile, a growing shadow banking system3 emerged as a result of unregulated lending to small- and medium-sized firms which, facing difficult access to the formal banking sector, looked to loan sharks for working capital.4 In the past several years, the shadow banking industry has nearly doubled in size to 25.6 trillion yuan, making up more than a third of total lending.5 Moody's Investors Service estimates that China's shadow banking may have reached 55 percent of China's GDP (52 trillion) as of 2012.6 In 2012, two thirds of the increase in credit came from sources other than bank loans.7 China's shadow banking sector has financed almost half of all new credit.8 While the money supply has expanded, much of the fresh credit has failed to flow into the real economy. Instead, this credit has been repackaged as shadow-banking products so as to avoid strict regulatory scrutiny, fuelling concerns over systemic financial risks.9

The shadow banking sector has also reshaped China's financial system, which, if less sophisticated, also used to be less complicated than its Western counterparts. Traditionally, the bulk of savings was deposited in Big Four and other commercial banks, which are largely state-owned. Chinese banks became accustomed to extending most of their loans to state-owned enterprises ('SOEs'). When Chinese banks got in trouble, they were bailed out by the government, and eventually by the taxpayers and depositors. Now savers can choose between traditional deposits and a variety of WMPs offered by lightly regulated trust companies and asset management firms in addition to banks themselves. Borrowers therefore enjoy a range of options, from the bond market, trust companies (making entrusted loans via a bank), to kerbside creditors.

Shadow banking is a complex and unregulated part of China's financial sector. This rapidly expanding segment tends to increase systemic and default risks. The Financial Stability Board in its third annual 'Global Shadow Banking Monitoring Report 2013' recommended that financial regulators enhance their monitoring framework to evaluate shadow banking risks and focus on credit intermediation activities that have the potential to pose systemic risks.10 Sensible regulatory instruments need to be designed to address these systemic risks. Nevertheless, little ink has been spilled on the risks posed by WMPs; likewise, the regulatory response to this segment has been slow and ineffective.

In the past three decades, Chinese banking law has become markedly more concerned with consumer protection. Laws and regulations were passed to require the disclosure of credit terms, protect financial privacy, police against predatory lending, limit the activities of debt collectors, and penalise loan sharks. These laws and regulations help protect consumers in the formal banking system. Financial consumers in the shadow banking sector however are less protected. The question therefore is whether the government and legislature may impose the 'conduct of business' rules on those players in the shadow banking sector. Put differently, the question is how regulators may intervene to attenuate systemic risks in the shadow banking sector so as to protect consumers.

This article is structured as follows. Section 2 discusses the key structural features of WMPs while Section 3 tries to understand the reasons for WMPs' popularity. As WMPs inherently involve systemic risks, Sections 4 illustrates these systemic risks by discussing three recent scandals. …

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