Despite deleveraging rhetoric, risks lurking in China’s financial system are coming to the fore and starting to hurt a highly sensitive group: repressed savers. Eroding investor confidence and blockages in the allocation of money could become far more dangerous than previously. Beijing has few options but to backpedal on rules meant to clamp down on the unruly underbelly of its banking system.

The problems range from hotspots in the nearly $3 trillion shadow lending industry to wealth management products that are posting their first losses. As COVID-19 strains household balance sheets, the strains are making for angry investors who want their money back.

For Beijing, that’s bad news. These were risks it was trying to contain through reactive rules laid out since 2018 and supposed to take full effect at the end of this year, aimed at reining in asset management and containing trust company funding, especially toward property investment. Now, regulators could find themselves squeezing lending channels at a time when they can’t get credit flowing to the real economy.

The whole point of the slew of regulations was to remove implicit guarantees and duration mismatches on such products. That’s exactly the problem at Sichuan Trust. Investors in its products are unlikely to get all their money back on 25.3 billion yuan ($3.56 billion) because the fund doesn’t have enough to repay them, online media outlet Caixin reported recently. Regulators have said investigators found evidence of embezzlement by shareholders.

Sichuan Trust’s investors poured billions into “trust of trust” products that are packages of corporate loans, stocks and bonds. Many of the underlying assets started to turn risky, and the firm needed new buyers to repay the old. Half of the products are supposed to mature this year, and another 12.3 billion yuan by 2022.

Angry mom and pop investors are up in arms because ultimately there is an implicit expectation that someone needs to return their money. Any social unrest when consumer credit is souring fast and disposable incomes aren’t rising could make a financial problem larger, and beyond the ability of regulators to contain. Households have poured money into savings deposits in recent months. Clamping down further on better-yielding alternatives and arbitrage risks hitting asset prices of stocks, bonds and other products that could force the vast network of non-bank financial institutions and small banks to recoil, leaving individuals in the red.

There’s no doubt that certain types of illicit shadow banking activities have been washed out by Beijing’s crackdown. As a whole, assets have contracted, but still stand at 59 trillion yuan. Banks’ off-balance-sheet assets funded by various investment management products have risen after an initial dip. That’s primarily because savers need somewhere to put their money; officials know that.

Beijing has been here before. In 2013, the failure of a high-yielding wealth management product set off protests in Shanghai. In 2016, crowds picketed government offices, demanding back their lost investments after similar debacles. Regulators moved to tighten rules around these gray products, often sold with little disclosure or oversight.

This time, tightening the noose isn’t an option. A closer look at the rules shows authorities know they can’t get their arms around the problems so easily. The various regulations have slack on the margins: The timeline for putting them in place is flexible and wealth management products can continue to invest in so-called non-standard credit assets, within limits. Meanwhile, several were recently reclassified into structural deposits that have become another target.

One way for Beijing to manage this is to eventually bail out aggrieved savers. But the pressure on state coffers is only rising. It’s unclear whether authorities can afford another rescue without acknowledging the rules aren’t working. An alternative is to find different places for investors to put their money, as seen in attempted reform of capital markets.

The most likely option -- and a setback -- would be to loosen the rules or delay implementation in the name of fighting COVID-19. It may buy social peace. But take that route, and the road to deleveraging will be a long one.


Anjani Trivedi
Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal. -- Ed.

(Bloomberg)