Investors in China who have poured $9 trillion in wealth management products (WMPs) and similar products remain hopeful that they will get bailed out in case of a major blowup despite reports that China's policymakers will not issue state guarantees, the Financial Post reported.
"Only after a WMP defaults in a high-profile way will investors start worrying about their money," Hao Hong, a Hong Kong-based strategist at Bocom International Holdings Co., said.
According to Hong, the bubble created by WMPs will eventually burst but losses will not be felt immediately because policy makers are trying to maintain market stability until the leadership restructuring in 2017.
The increase in interest rates imposed by the central bank has put pressure on WMPs, which is a major part of the shadow banking system in China. It is also putting pressure on the bond market where a big share of WMPs' funds was allocated.
Although banks will make up for investors when WMPs fail, the shortfalls could be too large for them to cover, Hong said.
This could be the reason why government intervention is less likely to happen. In February, regulators have been reported to be working on the new draft rules to make it clear that there will be no state guarantees on asset management products (AMPs) such as WMPs, mutual funds, trusts, insurance and other related products.
The government has been discouraged to make state guarantee because of the sheer size of the investment. Data compiled by the China Securities Regulatory Commission and Bloomberg show that AMP assets almost reached about 80 percent of the country's gross domestic product as of June.
The China Banking Regulatory Commission said that WMPs assets, the biggest category of AMPs, have reached around 29.1 trillion yuan ($4.2 trillion) at the end of December last year.
Steady returns
But investors continue to invest in WMPs because it produced steady returns. Out of the more than 181,000 products that matured in 2015, only 44 suffered losses, which were mostly sold by foreign banks. According to PY Standard, a Chengdu-based research firm, WMPs issued last week had an average annualized return of about 4.3 percent.
The People's Bank of China said that WMP bailout may not be possible because banks will cover the loss. However, most banks and major lenders are owned by the government.
"Major banks appear to have sufficient capabilities to offset the potential losses," Weiwei Fang, 35, who works at a consulting firm in Shanghai, said. "At least I think my principal should be safe."
The government's concern is that if WMPs fail, it would trigger a liquidity crunch. The average WMP matures in 127 days against 7.5 years for the average Chinese corporate bond. Because of this mismatch, bankers and WMP managers are vulnerable to market swings, which could lead to drop in asset prices and WMP selling at lower prices.
For policymakers, the challenge is to allow losing WMPs to fail before they enter the situation to contain the losses, said Andrew Collier, managing director at Orient Capital Research and author of a book on shadow banking. This will help limit the "financial crisis" to smaller banks, he said, while the government may move to provide some institutions with capital or allow them to merge with larger peers.