Fitch Ratings has warned that wealth management products (WMPs) issued by Chinese banks remain a key source of credit and liquidity risk for smaller financial institutions.
The credit rating agency noted that mid-tier institutions' increased reliance on WMPs for funding makes them especially vulnerable, especially as loss events rise.
Recently released data showed the outstanding balance of WMPs increased at the slowest pace in at least two years in the first half of 2016, reaching CNY26.3trn ($3.9 trillion) or 17% of system deposits.
Fitch estimates that among mid-tier banks, WMPs were equivalent to 43% of deposits at end-the end of first-half of 2016, up from 41% six months earlier and just 22% at end of first half of 2014.
WMPs may pose credit risks to banks, especially since money invested in them has not only gone to traditional asset classes, but has also been channelled increasingly into equity markets and forms of mezzanine financing, the credit rating agency said in a note.
The chinawealth.com.cn figures show that an average of 3,700 WMPs were issued per week in the first half of 2016, but only one issued by a domestic bank reported a loss over that period.
In contrast, there were 67 losses reported among WMPs issued by foreign banks, despite foreign banks having a much smaller share of the WMP market and lower WMP yields compared to domestic banks.
This compares to 44 and 51 losses reported in 2015 and 2014, and may point to increasing stress in the WMP market.
Banks could be forced to draw on their on-balance sheet loss-absorption buffers to bail out troubled WMPs in the case of significant stress, Fitch noted.
The value of WMPs issued during the first half of 2016 was CNY84 trillion, more than three times the outstanding balance, illustrating their high churn rates.
Liquidity risks are heightened by the fact that banks have increasingly been investing in WMPs themselves. At end of first half, 15% of bank-issued WMPs were held by other banks, up from 3% at end-2014.
Not only are China's mid-tier banks the most reliant on WMPs, they also have weaker loss-absorption capacity and thinner liquidity profiles than the state banks.
The Chinese authorities have been looking to tighten regulations on WMPs since late 2014, and in July 2016 circulated rules aimed at reining in the worst excesses.
Under the new regulations banks will need to set aside provisions for investment products until the risk reserve buffer reaches 1% of the banks' outstanding WMPs, while restrictions will also be placed on the investment scope for WMPs issued by smaller or less experienced banks.