UPDATE 1-In China, troubled shadow bank product tests no-default policy

Thu Jan 16, 2014 3:27pm IST

Stocks

   

* No-default assumption has fuelled shadow banking's rise

* High-yield trust product matures on Jan. 31

* Default could shatter "rigid repayment" culture

* But ICBC may face pressure to shield investors from losses (Recasts, adds banker quotes)

By Heng Xie and Gabriel Wildau

BEIJING/SHANGHAI, Jan 16 (Reuters) - A high-yielding investment product based on a loan to an indebted coal company is offering the latest test of China's willingness to permit defaults in its shadow banking system.

If the product, which is scheduled to mature on Jan. 31, fails to pay out as promised, it could shatter the widespread assumption that even risky investments carry implicit guarantees from the government and state-owned banks.

Economists say China's zero-tolerance policy towards default has distorted capital allocation, as credit flows to the firms most able to call on a bailout if problems arise, rather than those with the most productive businesses.

Industrial and Commercial Bank of China , the world's largest bank by assets, said on Thursday that it would not assume the "main responsibility" for repaying investors in a troubled off-balance-sheet investment product that it helped to market.

ICBC's shares have fallen this week amid speculation it would be forced to help repay investors in a 3 billion yuan ($496 million) investment product issued by China Credit Trust Co Ltd but marketed through an ICBC branch in central China.

"Regarding this unsubstantiated rumour, a situation completely does not exist in which ICBC will assume the main responsibility (for the trust product)," an ICBC spokesman told Reuters by phone.

The bank's statement leaves unresolved the question of how or whether investors in the product will be repaid. Industry players say the bank is probably seeking a resolution.

"Right now China Credit Trust, the local government, and ICBC are definitely at the state of intense negotiation, like a chess match," said a senior banker.

"But with this kind of situation, you have to wait for things to cool down, then deal with it. Because if you pay off or don't pay off, there are problems either way."

Other market watchers are hoping for a default that could shatter what insiders call the "rigid repayment culture" surrounding trust products and other off-balance-sheet investments.

"The background of interest-rate liberalisation is that even financial institutions can go bust. So how can you go around rescuing a non-government trust product?," Qiu Guanhua, bank analyst at Guotai Junan Securities in Shanghai, told clients in a conference call on Thursday.

TROUBLED LOAN

Trust loans and other forms of off-balance-sheet credit have helped fuel a rapid rise in China's corporate and local-government debt in recent years. Analysts are also concerned about Chinese banks' exposure to off-balance-sheet risks.

While shadow banking products typically don't carry a formal guarantee from the banks that help to create and sell them, bankers worry that investors widely perceive them as carrying a bank's backing.

That means that banks may face pressure to shield investors from losses in order to protect their reputations, even if they are not legally required to do so.

Several near-misses in recent years highlighted the pressure that banks and local governments face to shield investors from losses.

CITIC Trust was forced to delay payment on a product linked to a steel loan in Hubei province last year, but investors were eventually repaid when the local government apparently stepped in.

A wealth management product sold through Hua Xia Bank was able to repay investors - despite a default on loans used to fund a pawn shops and Audi sales agent in the poor inland province of Henan - thanks to a third-party guarantee on the loan.

The trust product sold through ICBC, called "2010 China Credit / Credit Equals Gold #1 Collective Trust Product", used the funds it raised from wealthy investors in 2010 to make a loan to unlisted coal company Shanxi Zhenfu Energy Group Ltd.

ICBC served as custodian for the funds and also helped sell the product to wealthy clients at a branch in central China's coal-rich Shanxi province.

But in May 2012, Zhenfu Energy's vice chairman, Wang Pingyan, was arrested for accepting deposits without a banking licence.

Following an investigation, China Credit Trust told investors that Zhenfu Energy had taken out high-interest underground loans totaling 2.9 billion yuan, bringing its total liabilities to 5.9 billion yuan and threatening its ability to repay the trust loan.

China's coal industry has been battered by falling prices over the last year. Several banks and trust companies are facing losses on loans to another coal company, Liansheng Resources Group.

($1 = 6.0460 Chinese yuan) (Editing by Jacqueline Wong)

  • Most Popular
  • Most Shared

Pending Reform

REUTERS SHOWCASE

Power Theft

Power Theft

India to invest $4 billion to tackle power theft  Full Article 

Debt Funds

Debt Funds

India monitors foreign flows into debt funds, may tighten rules  Full Article 

Bulgari Back in India

Bulgari Back in India

CEO: we shouldn’t have left India so we’re back  Full Article 

 Hindu "Modi-fication"

Hindu "Modi-fication"

Fears grow about Hindu "Modi-fication" of education  Full Article 

Weak Credit

Weak Credit

Hard to hit tax revenue target, credit weak - Jaitley  Full Article 

China Rate Cut

China Rate Cut

China surprises with interest rate cut to spur growth  Full Article 

Gold Imports

Gold Imports

RBI cautious on response to gold import surge  Full Article 

Economic Corridor

Economic Corridor

China commits $45.6 billion for economic corridor with Pakistan  Full Article 

Overseas Funds

Overseas Funds

RBI says overseas borrowed funds can be parked with banks in India  Full Article 

Reuters India Mobile

Reuters India Mobile

Get the latest news on the go. Visit Reuters India on your mobile device  Full Coverage