1. Local governments circumvent borrowing restrictions causing accumulation of debts into speculative investments.
2. All this is done via the proliferation of maturity mismatched WMPs (wealth Management Products).
3. Banks on the other hand are able to obscure or partially conceal credit risks info with this method.
4. The central bank forces bad debts to be rolled due to protectionism and nationalism reasons suppresses NPLs figures.
5. A rough picture can be obtained from previous post titled "China's Credit Risk Exposure"
THE METHOD
1. Central banks steps in requiring banks to minimize high risk loans or diversify its portfolio.
2. Bank sells the the loans to non-FIs and labeled "investments classified as receivables".
3. These items don't get reported as loan provisions.
4. The loans are packaged into WMPs and Collective Trust Products (CTPs) by trust companies and marketed to investors.
5. WMPs and CTPs are marketed to investors with higher interest than bank deposits. Thus passing the credit risks to investors.
6. Money collected from investors/buyers flows back to the bank.
7. Investor's may enjoy higher yield due to shadow banking (in the guise of WMPs) circumventing restrictions but provided that money are paid by borrowers promptly.
8. People (usually contractors, factory owners, speculators) who are rejected by banks turn to shadow banks with high interest rates.
THE PROBLEM
1. A recycling risks exist in the process when banks use trusts to relief its balance sheet by offloading its credit risks to investors.
2. WMP investors are exposed to high risks and may loses their deposits in favour of high yields unlike bank deposits.
3. WMPs money are funneled into real estate development / speculative bubbles.
4. A bailout is necessary if the trust companies are unable to pay to investors when loans default.
5. China's stock collapse was a warning on the upcoming dominos effect. Goverment micro managed the market and contained the effect to a certain extend.
6. Not sure if investors are aware of the risk they undertake otherwise it would spark massive protests.
WMPs RISKS
1. Mismatch maturity and its risk accumulation will be a key factor to trust products going bad.
2. To entice investors, WMPs have a shorter maturity compared to its investment in assets or projects with maturities in excess of few years.
Source: RBA, WIND Information
3. Common projects are building/upgrading of factories, roads, hotels, infrastructure which takes 2 or more years to start turning profit.
4.WMPs are also exposed to rollover risks which is seen by short term maturities taking a large portion of maturity level.
5. If China allows a large WMP to default, demand would drop and WMPs will stop rolling causing a forced liquidation of illiquid assets.
