Why banks’ wealth management products need stricter regulation

The macroeconomic downturn in 2012 has gradually shifted its influence from the real economy to the financial sector. The recently exposed problems regarding wealth management products sold by banks is only one of a number of possible hidden dangers and may be an early warning of the current financial risks.

Recently, the trust-based wealth management products sold on a commission basis by the Shanghai Branch of the China Construction Bank suffered 50% losses, private wealth management products, also sold on a commission basis by the Shanghai Branch of the Huaxia Bank, lost all of their investments, wealth management products from the Wenzhou Branch of China CITIC Bank suffered significant losses, and the list goes on. The problems with some wealth management products, which had always been regarded as risk-free in the country, became a hot topic throughout various sectors of society, and attracted the concern of the banking industry and the regulatory authorities when they were exposed at the end of last year.

At present, wealth management products sold by Chinese commercial banks are mainly divided into two categories. First, wealth management products from the banks themselves, with their own design, issuance process, management, and investments, mainly target ordinary investors; they have a low access threshold and make up a small total amount. Second, wealth management products from other institutions, such as insurance companies, funds, and trusts, which are sold by the banks on a commission basis; the banks only assume sales responsibilities and funding custody for these products, and are not responsible for product design, investments, management, or income distribution.

This second category of wealth management products generally has higher levels of potential income, and they are mainly targeted at private bank and corporate customers. These products, catering to high net-worth clients, have recently suffered a string of severe losses. What issues have caused the current losses and the ongoing disputes?

First, the effects of the macroeconomic downturn in 2012 have spread to numerous segments of the real economy in which these financial products are invested. In addition to the financial markets, the income for most of these products is derived from investments in real economy industries, so the downturn in the real economy directly resulted in investment losses, and even the loss of principal.

Second, a variety of factors led to accelerated competition in the banking sector. In order to maximize economic benefits, banks became greedy, and ignoring risks and the interests of consumers, sold wealth management products that were not fully developed nor well understood. High commissions for the banks were the main driving force in the sale of these wealth management products. It has been reported that the commission for the product manager is generally about 0.2% to 0.5%. In order to obtain higher returns, some bank managers cooperate privately with financial institutions and can get commission incomes of 0.8% or higher.

In addition, there are serious loopholes in the approval and management procedures for selling wealth management products. It is generally understood that the sale of these products only needs the approval of the bank’s head office, and the sales are then recorded with the local banking regulatory bureau where each branch is located. Due to the lack of investment experience and risk awareness, many banks do not have the ability to verify the quality of the products. It is a common phenomenon among those with some basic financial knowledge and who have purchased these products that many sales managers did not know how to explain and illustrate the wealth management products they were trying to sell.

The high-end products in private banks do not need to be recorded with the banking regulatory bureau and can be sold with only the approval of the general manager of the head office of the private banking division. This is one reason why the wealth management product crisis has primarily affected high net-worth clients. The private banking business in China is still in its formative stages, and participating banks, ignoring the risk warnings, began selling these so-called high-yield wealth management products to high-end customers before the banks themselves could thoroughly understand them.

Furthermore, because the banks that are selling on a commission basis act only as a sales channel, without taking responsibility for the possible losses, there has been, to some extent, heightened levels of enthusiasm for selling these products causing bank managers to seemingly forget the most fundamental banking principles.

It should also be noted that among the recent common disputes, investors themselves must take some responsibility. Some investors do not have sufficient knowledge of the risks involved with these wealth management products, and some investors also have the misconception that the wealth management products sold by the bank always guarantee the principal. Of course, if the bank had not misled investors, and reminded them of the risks involved during the sales process, many disputes could have been avoided. For example, for mutual funds, which have already been widely accepted by investors, banks are not blamed when the investments suffer a loss.

Finally, if the commercial bank has no ability or no intention of identifying wealth management products that are being sold on a commission basis, the bank must accept strict supervision, and even severe punishment. Second, the bank must follow strict procedures regarding classification, management, and information disclosures related to these wealth management products, and work to enhance the education level of investors. This will help investors to fully understand and appreciate the risks involved with these products, and allow them to choose wealth management products which match their own risk appetites and tolerances.