Chinese savers are increasingly turning away from the mainland’s traditional banking system, lured by the shadow banking sector’s promise of significantly higher yields. Despite the dramatic title, shadow banking is essentially just a name for financial institutions that operate outside the traditional, heavily regulated banking sector. Its largest segment, the trust industry, has seen explosive growth in recent years: As of the end of June, the amount of outstanding trust assets in China had reached RMB12.5 trillion (US$2 trillion), according to the China Trustee Association’s latest report (pdf). That’s equivalent about half of the country’s GDP in 2013.
However, few of those jumping ship from traditional savings seem aware of exactly where their money is going, or how safe it is. Getting a handle on just what the trust industry is made up of, and what it’s up to, can help shed light on its actual role in the Chinese economy and the risk it may pose to the general public’s pocketbook.
Makes and models
Put simply, a trust is a basket of assets including anything from loans to property to stocks to bonds. Trust companies then split the financial exposure to these assets into securities, known as trust products, which are then sold to investors. There are a variety of different trust products in the Chinese market today, and in order to understand the range available they can be broken down in terms of structure and industry. For structure, types of trust products include:
• a single unit trust, where the trust company creates a product based on the requirements of the customer
• a combined trust, in which a product is developed by the company and then marketed to investors
• a property management trust, a broadly defined product which involves the management of non-monetary assets on behalf of the client such as physical assets or intangible assets
The major industries for such products include industrial and commercial, infrastructure, real estate and finance, among others.
|Wealth Management Products – Areas of Investment (RMB, billions)|
|Rank||Industry||2013 balance||June 2014 balance||Change|
|4||Monetary financial services||350.792||424.745||73.953|
|5||Public facilities management||383.169||387.381||4.212|
|6||Civil engineering construction||308.962||384.503||75.541|
|7||Electricity, heat production & supply||360.286||384.462||24.176|
|9||Coal mining and washing||279.098||301.608||22.51|
|14||Ferrous metal smelting and pressing||86.853||94.447||7.594|
|Sources: China Banking Industry Wealth Management Market Year-end Reports for 2013(pdf), 2014(pdf)|
The breakneck growth of the trust industry—with assets under management increasing by an average of 53% a year for the past three years, according to a column from Reuters—is unsurprising, given that they typically pay more than double the 3.3% maximum one-year deposit rate that savers can get from mainland banks. Indeed, the average annualized return to investors in trust products in the first half of 2014 was 5.2%, according to data from Bloomberg.
Such a profound gap in investment yield is luring more and more individuals and companies away from traditional bank deposits, fundamentally changing the way the Chinese populace holds its savings. Of the funds raised for trust products, a quarter comes from wealthy individuals and companies, with the remainder from banks selling the trust products as wealth management products (WMPs) to individual savers, according to one report from the Wall Street Journal.
Many, including the International Monetary Fund, have expressed concern over the risk such products may pose to investors and the economy at large in light of such large premiums over the deposit rate. Strictly speaking, just because trust products offer a higher return compared to China’s state-controlled deposit rate doesn’t mean they are necessarily riskier; the returns could, in theory, be an approximation of what the real deposit rate might be without a government-imposed ceiling. But Chinese trust products go above and beyond making up for this gap, with returns outstripping levels one might expect from an ordinary deposit.
This suggests a significant risk premium is entailed by investing in these products. The most important factor contributing to this risk is the mismatch between short-term funds and longer-term investments. While many trust products only last for two to three years, borrowers may not be able to repay borrowings in such a short timeframe, especially those in the mining and infrastructure industries, according to a Reuters report. The two reports on the industry produced so far by the National Banking Wealth Management Registration System (overseen by the China Banking Regulatory Commission) show heavy investment in bonds & currency, cash & deposits and non-standardized creditor assets.
|Wealth Management Products – Types of Assets Held|
|Asset class invested in||Dec 31, 2013||Jun 30, 2014|
|Bond market & currency||38.64%||38.81%|
|Cash and deposits||25.62%||28.68%|
|Non standardized credit assets||27.49%||22.77%|
|Qualified Domestic Institutional Investor||0.44%||0.34%|
|Wealth management direct financing tools||0.16%||0.24%|
|Credit asset transfer project||0.02%||0.01%|
|Goods and other assets||0.01%||0.01%|
(Note: Non-standardized credit assets include creditor assets that are traded outside bank and stock exchange markets, including but not limited to credit assets, trust loans, entrusted loans, acceptance bills, letters of credit, accounts receivable, and equity financing with a buy-back clause.)
This leads to the broader question: How much risk is posed by the borrowers of all this cash? Most trust companies have ostensibly sound assets, but the trust sector can attract companies desperate for cash, such as overextended real estate, mining and local government developers. And while trust products are sold under the umbrella term of “wealth management products” (WMPs) through major banks, the banks don’t always guarantee them. One notorious example came in 2012, when customers of Huaxia Bank who had been sold a WMP were told they would not be getting their money back. Chinese media portrayed it as a one-off event, but there have been several cases this year of trusts on the verge of default or who have delayed investor payouts.
As for exactly who is stuffing all these assets into the baskets, there are around seventy members of the China Trustee Association, the largest members of which include the trust companies Citic Trust, China Foreign Economy and Trade Trust, China Credit Trust, Pingan Trust and Yingda International Trust, according to KPMG (pdf). Companies in the industry are mostly either state-owned, local government-controlled or have a large pool of diversified shareholders comprising government-owned and privately-owned businesses.
As a result of growing oversight by the PBRC, corporate governance in the industry at least appears to be steadily improving. A ratings system is used by the regulator to oversee trust companies in which companies with lower scores are subject to more regular and stringent oversight and restrictions. Of course, that may not guarantee the actual safety of these products for ordinary consumers, as anyone familiar with the role of credit rating agencies in the US subprime mortgage crisis of ’08 can attest to. ♦
Authors: Francis Zhao, Hudson Lockett, Ryan Henderson