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Structured deposits in China tumble into a 'regulatory grey area'

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Structured deposits in China tumble into a 'regulatory grey area'

Structured bank deposits in China have skyrocketed to 9 trillion yuan as savers look for potentially higher returns, but could attract the scrutiny of regulators fresh from a clampdown on wealth management products that funded high-risk projects, analysts said.

As was the case with wealth management products before a regulatory clampdown that began in 2017, structured deposits are proving popular among Chinese savers looking for an alternative to savings accounts that provides potentially higher returns, data from the People's Bank of China shows.

Structured deposits comprised 5.9% of Chinese banks' total deposits as of the end of April, compared with 4.6% at end-2017 and 3.7% at end-2016.

In the first four months of 2018, structured deposits grew 45.6% year over year to 3.285 trillion yuan at the seven largest Chinese banks: Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd., Bank of China Ltd., China Development Bank, Bank of Communications Co. Ltd. and Postal Savings Bank of China Co. Ltd. At small and midsize banks, such deposits jumped 53.9% to 5.867 trillion yuan for the first four months of the year.

The attraction of these products to customers is clear. While structured deposits offer returns that rise and fall according to the performance of a chosen index or financial asset, the initial deposit is paid in full at maturity. Generally, the performance of these products depends on the strength of a bank's investment strategy, including its use of derivatives and other instruments.

Customers in China are hoping for an annual return of at least 4%, similar to previously popular wealth management products that were backed by a lender's implicit guarantee.

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On, off the regulatory radar

Chinese banks have issued trillions of yuan of high-yield wealth management products, frequently pumping the resulting funds into potentially high-risk infrastructure projects or complex investment instruments.

Xia Le, chief Asia economist at BBVA Research in Hong Kong, said one key reason for the growth in structured deposits has to do with the recent regulatory clampdown on wealth management products. Finalized in April, new asset management rules require banks to be more transparent about their wealth management products, while prohibiting them from offering implicit guaranteed returns and from investing funds from those products into complex, often opaque multilayered investments.

Well before the rules were finalized, banks appeared to already be pulling back. Outstanding wealth management products grew only 1.69% to 29.5 trillion yuan in 2017, compared with 23.6% in 2016, according to the China Central Depository & Clearing Co., an industry body.

"Because of the new asset management rules and other regulations, banks have to attract customers through selling [more high-yield] structured deposits," Xia said.

Thus far, structured deposits have escaped a regulatory clampdown, and might continue doing so. "Banks' structured deposits are normal on-balance-sheet business if they are truly linked to derivatives," said Chen Shujin, head of financial research at Huatai Securities in Hong Kong. "However, they will be problematic if banks are actually attracting customers with high interest rates."

Xia added that without targeted supervision, banks can take deposits to invest in projects previously funded by wealth management products.

"The question is whether those structured deposits are really linked to derivatives or are banks just using those funds for their capital pools," Xia said. "The regulators asked banks to reveal wealth management products' underlying assets in the new asset management rules, but haven't imposed similar rules on structured deposits."

Structured deposits could significantly increase banks' liabilities, leading some of them to adopt aggressive and high-risk asset allocation strategies, warned Liao Zhiming, an analyst at TF Securities in Shanghai.

In addition, Liao said some smaller banks are not qualified to trade derivative products.

Amid all this, Chinese banks are having to readjust operating strategies. Impacted by tightening monetary policy and competition from wealth management products, Chinese banks have seen a slowdown in deposit growth in recent years. Total deposits were 155.575 trillion yuan for the first four months of 2018, 8.3% higher than the year-ago period of 2017, which recorded 11.4% growth from the corresponding 2016 period.

Liao could see regulators setting a cap on structured deposits as a proportion of total deposits.

Xia added that regulators should make sure structured deposits match their underlying investments, as required now for wealth management products.

"Structured deposits have been growing in a regulatory grey area," Xia said. "They must really be linked to derivative products, and not just backed by banks' principal-guaranteed promises."

As of June 1, US$1 was equivalent to 6.42 Chinese yuan.