By Zheng Li and Nathaniel Taplin
SHANGHAI/BEIJING (Reuters) - China's banking regulator and main bond clearinghouse have asked commercial banks to reduce rates they offer on high-yielding wealth management products (WMPs), five sources told Reuters, an apparent back-pedalling on commitments to let markets price credit.
The move to suppress returns on WMPs would cut the cost of capital for cash-strapped firms relying on the estimated 20 trillion yuan ($3 trillion) industry for costly credit to stay afloat, and reduce the appeal of such products to retail investors, which could boost alternative investments such as Chinese stocks, which have had a dreadful start to 2016.
WMPs, marketed by banks but often backed by third-party loans or other risky assets, offer interest rates of up to 10 percent or higher on some products, even though domestic benchmark rates and bond yields have fallen sharply over the past year.
The high level of precarious indebtedness is of growing concern as Chinese policymakers try to bolster economic growth and financial stability at a time of high volatility in its currency and share markets.
Reuters reported on Tuesday that new non-performing loans (NPL) held by Chinese banks more than doubled in 2015 from the previous year.
"Given that CBRC (China Banking Regulatory Commission) has already said that the key task for 2016 will be risk control, it's quite telling that they're now telling banks to reduce these WMP yields," said Oliver Barron, an analyst at the NSBO macro consultancy in Beijing.
"Many trust loans, for instance, were issued two years ago when commodity prices were still sky high, and any products that sent funds to those parts of the industrial sector may have repayment difficulties at the old high rates."
The sources, who have direct knowledge of the matter, said the regulator and clearinghouse called the banks to a "training session" last week to offer informal guidance on lowering WMP rates but did not specify any particular class of WMP.
They said the authorities wanted to lower yields across the board to control the scale of assets in this investment space.
"I think some institutions are having trouble holding on, and so they will use this guidance as an excuse to lower yields," said one source with knowledge of the matter.
A source in one commercial bank's wealth management division welcomed the intervention, as margin pressure was intense, so now the industry could afford to cut returns without hurting their competitive position.
"No one dared to lower yields first; everyone was waiting to see who would admit defeat," he said.
A separate wealth management banking source said that after receiving the notice yesterday, new product offerings were already beginning to offer lower rates.
In such a weak domestic economic environment, analysts have raised concerns that many of the assets underlying such products may be of poor quality, shifting default risks onto retail investors and directing more credit to low-quality firms.
Figures from a recent Reserve Bank of Australia study suggest that banks, directly or indirectly, account for only about a third of WMPs, with trusts and other channels accounting for the rest.
It is not clear if the CBRC's guidance will be extended to the latter.
Third-party data from CN Benefit, an independent research firm that tracks the wealth-management sector, found that WMPs were increasingly backed by bond and money market instruments in the second half of 2015, even as bond defaults have accelerated sharply over the past year.
Moreover, a recent Reuters analysis of exchange data found that a disproportionate percentage of new bond listings on the Shanghai exchange were issued by local government investment or infrastructure firms, a major source of China's existing nonperforming debt problem.
Such entities often find it easier and cheaper to raise capital because of a perceived state guarantee, while private and more innovative firms struggle to get financing.
With stocks tumbling, the real estate market still vulnerable and high-rated bond prices bid up to multi-year highs, WMPs are one of the few options left for domestic investors seeking high returns.
Retail investors also often assume that banks will stand behind such products, even when marketing materials indicate that they are not guaranteed.
The CBRC could not be reached for comment, while the Central Depository and Clearing Corporation declined to immediately comment.
(Additional reporting by Zhao Hongmei and Clark Li in BEIJING; Editing by Will Waterman)