Bank of America Merrill Lynch cautions against fears that China's banking system could be vulnerable amid recent regulatory concerns about a plethora of wealth products by the industry.

Following the recent unveiling of the China Banking Regulatory Commissions’ new rules on wealth management products, Bank of America Merrill Lynch has responded by saying credit supply will only be marginally affected and suggests a way to better understand China’s shadow banking and WMPs.

In its China macro viewpoint report, titled “Bank WMPs, tunnelling, and shadow banking”, BofAML reiterates its view that the prospect of a looming financial crisis is an “exaggeration”. Meanwhile other industry experts are not so optimistic, in light of credit agency Fitch downgrading China's local-currency rating from AA+ to A- last week.

The new CBRC's measures say that a WMP’s exposure to non-conforming loans cannot exceed 4 per cent of the issuing bank’s total assets, or 35 per cent of the WMP’s total assets under management.

BofAML said: “First, credit supply will be little impacted by the new rules. The markets' scare on liquidity squeeze was overdone. Second, the best way to understand China's shadow banking and bank WMPs is to put commercial banks' efforts to circumvent regulations on loan quota and deposit rates at the centre of the universe.”

It added that while it does see risks of rapid financial innovations and deregulation, the bank predicts an imminent financial crisis seems to be an exaggeration. “Further improvement in regulations and structural reforms could prevent current problems from morphing into systemic risks in China, in our view,” it said.  

Credit supply

BofAML said that it believes the CBRC's new rules will likely have very limited downside impact on China's growth. “We believe these new regulations will eventually help to strengthen investor confidence in the health of China's financial system.”

Chinese banks will have a 10-month grace period to cut the ratio of non-standard-investment-to-WMP from an estimated 44 per cent to the required 35 per cent. “Since the CBRC did not cap the growth of banks' WMPs, the sector will rapidly increase their outstanding WMPs by adding standard investment in fiscal bonds, corporate bonds and securitised assets,” BofAML said.

Cartel

According to the report, funding in China has long been dominated by commercial banks, which are organised like a cartel enforced by regulators via loan quota and deposit rates. “China's non-bank financiers are better defined as banks' appendices which serve as tunnels for banks to move assets off-balance-sheet in order to bypass regulations on loan quota and types of borrowers,” it said. Banks also need to compete for funding sources by selling WMPs which can circumvent regulations on deposit rates.

Most existing estimates of the size of China's shadow banking vary from RMB 15trillion ($2.4 trillion) to RMB 25trillion. However, BofAML believes estimating the total scale of shadow banking does not make much sense without a clear analysis of how the financial system actually works.  

Optimistic

“Our RMB11 trillion estimate of China's "shadow banking" does not mean that we believe there is little risk in the country's financial system. By contrast, we see many non-negligible risks in both the commercial banking sector and non-bank financial institutions, however this does not lead us to take bank WMPs on the whole as subprime debt, CDO or Ponzi schemes,” Bof AML said.

The bank is are relatively optimistic for three reasons: “(1) the Chinese government is on top of the shadow banking issues and keeping up with regulations; (2) China can still maintain relatively high growth for the next decade; (3) the central government can take on more responsibilities in infrastructure FAI,” the report said.