Are Wealth Management Products (WMPs) destroying the financial system in China? Financial literacy is crucial for stability and informed investment decisions.
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Wealth management products help to raise funding for small firms in China

Are Wealth Management Products (WMPs) destroying the financial system in China? Financial literacy is crucial for stability and informed investment decisions.

Imagine you want to start your own business without funding. Whom should you resort to? Most people would think of taking out a loan from the bank. But it is common sense that the bank would not lend for no reason. In under-developed and developing countries, taking out a loan required for an entrepreneur is much harder given the relatively new financial system.

However, for a country to grow and get rich, the economy needs new business ideas and innovations. This gives rise to the shadow banking system outside of traditional regulated banking. Unlike taking out a loan in the bank, becoming a lender in the shadow banking system is much easier. Wealth Management Products (WMPs), a type of shadow banking in China, helps support the funding of small and medium-sized enterprises (SMEs).

What are wealth management products in China?

Wealth Management Products are a type of investment issued by mostly commercial banks. WMPs are created to reduce the level of risk in the loans taken out by Small and Medium-sized Enterprises (SMEs). Due to their scale and financial capacity, the likelihood of not repaying their loan is higher than that for large corporations. Therefore, to reduce the default risk, the banks pile up all the loans taken out by SMEs and package them as investments with high returns. Attracted by the high return of WMPs and compelled by the authority of the commercial banks, people would invest some part of their savings in the bank account in the WMPs issued by the same bank. 

Most WMPs in the market have the following characteristics: the lowest level of risk, a maturity of 1 to 12 months, close-end, and non-net. It is not hard to understand investors’ mentality to reduce the risk in their returns. Hence, a maturity of less than a year is a safer investment. In the context of WMPs, close-end means that investors cannot redeem WMPs at any time. Non-net-worth products mean that investors would be informed about the expected return at the beginning of the investment. Based on the following features, we can find that banks try to make a balance between informing the level of risk and making WMPs an attractive investment.

WMPs need to be regulated but also protected to meet the funding needs of SMEs and financing needs of Chinese investors.

Xin Chen

Why are WMPs important to the Chinese economy?

The importance of WMPs can be addressed in both supply and demand. As mentioned above, the major benefactors of the WMPs are those SMEs. Being the backbone of the Chinese economy, they account for over 60% of total GDP, 79% of job creation, and 68% of exports. According to data, the rejection rate of loan applications by SMEs is gradually decreasing each year. This reflects that the government has already realized the significance of supporting small and medium-sized business owners.

From the side of demand, WMPs help to accelerate the asset management industry in China. With an extremely high saving rate of 45.9% in 2021, bank savings deposits continue to dominate wealth accumulation in China. WMPs as the alternative to deposits in the banks can help to channel the wealth accumulation to investing in new businesses and enterprises. In short, the existence of WMPs helps China to move toward a more mature capital market like those in the US and Europe.

Given the features of Chinese investors domestically, WMPs issued by commercial banks are a better alternative to other types of investments than non-bank financial institutions. Most investors in China are young. According to the data posted by the White Paper on Wealth Management for City Dwellers in the Longevity Era, most people aged 26-55 are the main force of insurance consumption, with 33.13% of them aged 26-35. On top of that, Chinese investors domestically lack basic financial knowledge.

In general, Chinese investors have a positive attitude toward wealth management but irrational investment behavior. This is due to both a lack of financial education in the schools or academic institutions and the immature financial environment in the Chinese economy. Hence, WMPs have become a rather reliable and trustworthy way of investment in China.

Are Wealth Management Products (WMPs) destroying the financial system in China? Financial literacy is crucial for stability and informed investment decisions.
Credit. Midjourney

What are the risks behind WMPs?

The largest risk behind WMPs is the default risk, which means that SMEs are unable to repay their debts. According to data and research, 15% of the WMPs fail to produce the rate of return promised. This displays that although the banks provide a high return to attract investors, getting money back is not guaranteed by the banks.

Another risk comes from regulation. After its introduction in 2013, Alipay, the iconic digital payment method in China, has made a seamless two-way link between users’ money and money market funds. When the money is idle, users can “invest” with one click to earn income; when the money is used, they can also “redeem” with one click to pay for consumption. This creates a huge regulatory arbitrage, where Alipay circumvents the regulatory authority to amass a large pile of money for investing. By doing so, Alipay can profit from charging fees on both the users and projects funded. However, such regulatory arbitrage destabilizes the financial system in China. Therefore, Alipay is currently regulated by the People’s Bank of China.

Should the government forgo WMPs?

The Chinese government has enforced different regulations and supervision on the market of WMPs. Among them, The Guiding Opinions on Regulating the Asset Management Business of Financial Institutions released by Chinese financial authorities (PBC, CBRC, CSRC, and SAFE) specifies the standardized and restricted release of WMPs. However, the share of WMPs in Chinese GPD has gradually decreased over the years. According to Fitch Ratings, WMPs in China remained at around 25% of nominal GDP at the end of 2021. Hence, WMPs are still quite resilient.

From the side of demand, WMPs still serve as the investment choice of the private investable funds held by individuals. A report made by the RUC FinTech Institute predicts that the investable funds by the downward-reaching market will likely reach 101.7 trillion by 2022. The downward-reaching market represents the consumers who live in lower-tier cities of China. Unlike people in Beijing and Shanghai, they lack the basic knowledge of finance in general. Therefore, banks as authorities are more likely to target those investors through promoting WMPs.

In short, the Chinese government should continue to consolidate the regulations and disciplines of the WMPs. Continuously supervising commercial banks, especially the loan-to-deposit ratio, and prohibiting questionable behaviors in the financial system can all help to maintain the fairness, justice, and responsibility of the market. The next step of regulations should tackle the problem of WMPs in FinTech.

in the first quarter of 2020, the scale of wealth management reached more than 100 trillion yuan, and FinTech brought positive significance.

Ping Lian, chairman of the China Chief Economist Forum

Fortunately, the Chinese government has already taken the step of regulations and investigations while confronting cases like Ant Group and Evergrande Group’s illegal fundraising. However, all the regulations imposed should come at the expense of killing or harming the industry.

Conclusions

As mentioned, WMPs as the major source of funding for SMEs are pivotal to more than half of the GDP in China. Without WMPs, the lifespan of SMEs in China could potentially be curtailed. Investors lacking eligibility for premium asset management services still need WMPs for investments. Designed to address these needs, while not flawless, WMPs undeniably wield considerable influence by channeling capital into the Chinese economy.

Apart from regulations, one long-term goal to reduce the financial instability caused by WMPs is to increase the financial literacy of the general public in China. As the Chinese capital market matures, investors should receive more professional training or advice on investing if they are not gullible and are aware of the risks behind investing. The probability of events like the fall of Evergrande Group could be reduced significantly.

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Journal reference

Chen, X., Sun, S., Zhu, C., Liang, D., & Zhang, K. (2023, February). Wealth Management Product in China. In International Conference on Business and Policy Studies (pp. 1225-1238). Singapore: Springer Nature Singapore. https://doi.org/10.1007/978-981-99-6441-3_111

Xin Chen is a graduate student in economics at New York University in the United States. She obtained her bachelor’s degree in economics at NYU with cum laude honours. Her interest lies in the area of international financial markets, particularly those in both China and the US. Currently, she is exploring the intersection between macroeconomics and financial markets.