Figures released by the central bank show that at the end of February 2018, the individual and institutional structured deposits of commercial banks increased by 44.9% over last year. In comparison, the total of all banks’ deposits increased by only 10% over the same period.
This sharp increase in structured deposits is closely connected to the requirement in the Guiding Opinions on Regulating the Asset Management Business of Financial Institutions that the bank wealth management products must restructure to promote the products’ net value management.
The new asset management rules mentioned above signify that bank wealth management products with an existing market size of close to RMB30 trillion will cease to enjoy the rigid guarantee of principal payment provided by banks, whereas many existing customers of bank wealth management products are risk averse investors who seek guaranteed principal and returns. As banks wish to avoid having such customers turn to investing in other products after the loss of the rigid payment guarantee and due to the recent ratcheting up of the pressure to attract deposits, structured deposits that not only satisfy the business requirements of both parties but also satisfy regulatory requirements have become the explosively popular product on the market.
And it is not only individuals. A significant number of listed companies have also adopted structured deposits as one of the main means of cash management. For example, China Molybdenum issued an announcement on 30 March 2018 to the effect that it was planning to use idle self-owned funds not exceeding RMB35 billion in the aggregate to purchase structured deposit products in the next 12 months.
What kind of product are these so popular structured deposits? Pursuant to the Standards for the Statistical Classification of, and Codes for, Deposits (for Trial Implementation) issued by the central bank in 2010, the term “structured deposit” means a deposit attracted by a financial institution that embedded in financial derivatives and that allows depositors, on the basis of bearing certain risks, to earn higher returns through linkage to fluctuations in interest rates, exchange rates, an index, etc., or linkage to the creditworthiness of a certain entity.
To meet the demand of risk-averse investors for the guarantee of principal payment, structured deposits are often of a type with guaranteed principal payment and then, on this basis, enhance returns by adding interest rate, exchange rate, index and other such derivatives. The main difference between ordinary deposits and structured deposits is the fluctuation in the interest on structured deposits and the certain degree of risk that they entail. So the expected interest on such structured deposits is generally higher than the interest rate on bank deposits of equivalent term.
The main difference between structured deposits and structured wealth management products is that the principal of structured deposits is invested in bank deposits, whereas that of structured wealth management products is generally invested in low-risk fixed return assets, with the principal and expected returns falling outside the coverage of deposit insurance.
Of course, what is of greatest concern to customers with regard to structured deposits is different from that which is of most concern to banks. For the customer, of greatest concern is the security of the funds and its returns, whereas for the bank what is of most concern includes, at minimum the following points:
Whether the product design and sales are in compliance with laws and regulations. Article 23 of the Administrative Measures for the Sale of Wealth Management Products by Commercial Banks issued by the China Banking Regulatory Commission (CBRC) in August 2011 requires that, “where the name of a linked structured wealth management product includes the name of the linked assets, the percentage of linked subject assets of the total capital of the wealth management funds must be specified in the name of the product or it must be specified that the underlying assets are linked with expected returns of the principal”.
In practice, all banks, in selling structured deposit products, handle matters with reference to the regulations on wealth management products mentioned above. Furthermore, article 22 of the Interim Administrative Measures for the Personal Wealth Management Business of Commercial Banks specifies that, “if the wealth management plans sold by a commercial bank include structured deposit products, the commercial bank must separate the underlying assets from the derivatives trading portion. The underlying assets must be managed as for savings deposit business and the derivatives trading portion as for financial derivatives business.” It is precisely on the basis of this provision that the majority of banks refer to similar practice for the sale of wealth management products when engaging in structured deposit business.
Whether it has the qualifications to trade derivatives. The reason that structured deposits can offer higher returns than those of ordinary term deposits is, no matter nominally or substantively, mainly due to options, in other words, investment in derivatives. Article 7 of the Administrative Measures for the Derivative Trading Business of Banking Financial Institutions specifies that, “a banking financial institution that engages in foreign exchange, commodity, energy and equity-related derivatives trading, as well as trading in derivative product transactions in the field must have derivatives trading business qualifications approved by the China Banking Regulatory Commission.”
To obtain such qualification, a bank must have sound internal systems, a specialized derivatives trading team, the appropriate trading premises and equipment, and a sound trading system. For the great majority of urban commercial banks and rural commercial banks, the costs of building a team and setting up a system far outweigh the benefits that obtaining such qualifications could bring. To date, the number of urban commercial banks and rural commercials that have obtained such qualifications is low, but this does not prevent them from engaging a qualified investment manager to carry out derivatives investment for them.
Consistency of reality with name. At this time, where the popularity of structured deposits has exploded, it is necessary to check whether relevant products genuinely have the nature of a structured deposit or whether a bank is relying on this to subsidize the attraction of deposits. Under the current highly effective regulatory regime, the rules for the administration of structured deposits are soon to come down the pipe. At this juncture, where structured deposits are selling like hotcakes, commercial banks need to take precautions by enhancing their trading capabilities and judgment of trends, and increase returns through appropriate investment strategies so as to cause their structured deposits to be worthy of the name.
Wu Jiejiang is a partner at Jingtian & Gongcheng