China to crack down on banks' Ponzi-style "fund pools"

(Reuters) - China's banking regulator will strengthen regulation of banks that use faulty accounting practices to disguise losses on the high-yield investment products that are increasingly replacing traditional deposits as banks' key sources of funding.

Industry insiders have long expressed concern about banks who aggregate the proceeds from the sale of various wealth management products (WMPs) into collectively-managed "fund pools", rather than clearly linking each product to a specific set of underlying assets.

This practice prevents banks from admitting losses, or possibly even learning about them internally, because inflows from the sale of new products can be used to deliver the promised returns on previously issued products.

The swift rise of WMPs in recent years is generally positive for China's financial system, said Yan Qingmin, assistant to the chairman of the China Banking Regulatory Commission (CBRC). Yan's remarks from an industry forum on Tuesday were posted on the commission's website.

"The banking industry's wealth management business has channeled funds that might otherwise flow into high-interest underground loans, illegal fundraising, and commodity speculation and has upheld financial stability," Yan said.

But he said CBRC would remain vigilant against fund pools and other risks.

"Individual banks have problems such as insufficient disclosures, inadequate risk warnings, non-standard sales practices, and improper 'asset pool' wealth management business, which has blurred risk awareness," he said.

Total WMPs outstanding reached 7.4 trillion yuan ($1.2 trillion) by late January, up from 7.1 trillion yuan at the end of 2012 and only 500 billion yuan in 2007, the director of CBRC's innovative regulation department, Wang Yanxiu, said at the forum, China Business News reported on Wednesday.

The end-2012 total amounts to 7.3 percent of total bank deposits at that time. The estimates do not include WMPs issued by trust companies.

The rise of WMPs has been fueled by Chinese depositors' hunger for yields above the central bank's benchmark deposit rate, currently set at 3.0 percent for one year.

WMPs, which are not subject to the cap on traditional bank deposit rates, are typically backed by money-market instruments, bonds, corporate bills, or high-interest loans to risky borrowers such as real-estate developers and local governments.

WMPs that carry bank guarantees typically promise interest rates between three and five percent, while non-guaranteed products sometimes promise 8 percent or higher.

But regulators and bankers themselves have expressed concern about the lack of transparency about the underlying assets of WMPs.

In a widely-noted opinion column published late last year, Bank of China chairman Xiao Gang called for increased regulation of shadow banking and highlighted the risk of the asset pool model.

"When faced with a liquidity problem, a simple way to avoid the problem could be through using new issuance of WMPs to repay maturing products. To some extent, this is fundamentally a Ponzi scheme," Xiao wrote.