Whack-a-mole

China's bank watchdog is pushing on a balloon

Chinese regulators are cracking down on short-term investments - again. The country's bank watchdog is considering barring smaller lenders from the riskier and most lucrative parts of the country's $3.5 trillion market for wealth management products, Reuters reported on July 27. The move should help to protect savers and limit the hazards caused by repackaging loans as short-term investments. But it will probably just shift risk to different parts of the financial system.

According to the draft rules, authorities want to prevent banks with net capital of less than 5 billion yuan ($750 million) and less than three years' experience in the industry from issuing anything other than simple investment products backed by assets like cash and bonds. Regulators can also bar any bank that has not been given a "good" supervisory rating from selling more exotic products to retail investors.

The intervention is welcome, and overdue. Mom-and-pop investors bought almost half of the wealth management products issued in the People's Republic in 2015, according to credit rating agency Moody's. Many punters assume anything sold by a bank comes with an implicit government guarantee.

Smaller banks have led the charge in an industry which has more than doubled in size since 2012, aggressively marketing high-yielding products backed by longer term assets including corporate loans. Some of these repackaged loans have ended up on the balance sheets of other banks - spreading the risks of loose lending through the financial system.

Tighter rules would restrict the issuance of more exotic products to larger, better-capitalised state banks that don't need to compete so hard for depositors. Some riskier investments will probably shift to non-bank institutions not backed by the government. That should help to draw a clearer line between safe bank deposits and speculative assets.

Shares in mid-tier Chinese banks tumbled on the news, reflecting fears that the crackdown will further squeeze earnings at lenders already under pressure from competition for deposits and rising bad debt charges. These institutions will probably respond by looking for ways around the rules. Every time authorities suppress one type of off-balance sheet finance, banks simply invent new forms of risky products. Don't bet against them finding a new loophole this time.