Blame game

Not our problem, sir

Almost exactly four years ago Bernie Madoff was arrested, setting into motion a chain of events that ended with a 150-year prison sentence for one of the biggest cases of financial fraud that the US has ever seen.

But at $65 billion in investor losses, the scale of Madoff’s crimes appear to be small fry compared to the concerns that are circulating in China right now. The country could be facing a trillion dollar ponzi scheme, with investors and regulators’ fears heightening after a high profile default of a wealth management product (for an earlier article alerting readers to the issue, see WiC172, where the boss of Bank of China sounded the alert on this investment class).

Earlier this month, more than 40 investors took to the street in Shanghai’s financial district to protest against Huaxia Bank, after losing money invested in one of its wealth management products.

The product was issued by Zhongding Wealth Management Investment Centre, and sold by an employee at a Huaxia branch in the suburbs of Shanghai, reports Reuters. But the bank said that the employee was acting without authorisation. Since the investment was offered by a rogue agent, Huaxia is arguing that it didn’t underwrite the product, reports Securities Daily.

“We sympathise with investors,” a Huaxia spokesman told Century Weekly. “But now we can only resolve this through legal channels.”

The bank employee has since been arrested, although her husband believes that his wife is not to blame.

“The products had been on sale for half a year, and now the bank is pushing the responsibility on her. Why is the bank sacking her now, when the product has failed, rather than six months ago?” the man, called Xu, said on Netease, a news portal.

Investors were originally offered returns of 11-13%, much higher than bank deposit rates, for a minimum investment of Rmb500,000. The money raised was then invested in four businesses in Henan province and has since disappeared, says Securities Daily.

Investors are angry that Huaxia seems to be blaming the employee, rather than take responsibility itself.

“Our money was deposited into Huaxia’s accounts via the branch counters. For ignorant investors like us, we were buying the Huaxia Bank’s product and we want our money back from Huaxia,” one told the South China Morning Post.

“Huaxia is state-owned, and to some extent, it is doing business under the government’s directions. How can we trust the government and the Communist Party… now that a state-owned bank refuses to pay our money back?” claimed another.

Wealth management products have become a significant part of China’s financial system, with an aggregate of Rmb12 trillion ($1.91 billion) having been issued, according to Fitch, a rating agency.

While the default in Shanghai is not the first failure of a wealth management product, it is the highest profile so far. And should Huaxia compensate investors, it could also set a precedent for further payouts when other investments turn sour. “If the banks foot the bill, there will be no end of trouble,” predicted CICC, a domestic investment bank, in a report cited by 21CN Business Herald.

But others are more concerned that the sale of similar products could be reaching such a scale that their chameleon nature could end up subverting the banking system. As the Financial Times’ Alphaville blog explains, wealth management products can have a bewildering effect on bank balance sheets, where they can be included to satisfy loan to deposit ratios, but then removed to reduce reserve requirements.

“These hidden balance sheets are beginning to undermine the integrity of the banks’ published balance sheets,” Charlene Chu of Fitch Ratings told the FT. And many suspect the failure of Huaxia’s product will not be the last.

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.