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China's banking regulator has ordered the country's banks to set up a firewall between their popular wealth management products and their cornerstone lending to prevent risk.
Banks are required to establish a special department to carry out wealth management business separately from loans and other transactions by the end of September, according to a document released by the China Banking Regulatory Commission (CBRC) this weekend.
The CBRC's new regulation of this fast-growing but shadowy part of China's financial system came after it demanded in May that investment by wealth management products be in line with the state's macro and industrial policies and support the real economy.
Such wealth management products are considered an important part of China's shadow banking system, a complex and unregulated sector that has emerged and grown significantly in China in the last few years.
Under the new regulation, an independent risk control mechanism for wealth management products must be put in place for all banks.
Commercial lenders are also required to install firewalls between the wealth management products they design and those sold through their agency or between different products.
Banks that fail to set up separate wealth management business departments will be subject to "corresponding prudent regulation measures," the CBRC warned, without giving further details.
The low rates of bank deposits have led many savers to invest their money in speculative real estate projects or dubious investments known as wealth management products offered by banks and finance companies promising higher rates of return.
Problems such as misleading sales, inadequate information disclosure and banks' failure to separate wealth management funds from their own capital have emerged during the rapid growth of the business, the CBRC document warned.
Promotional materials for wealth management products should not contain content about guaranteed payment of interest or repayment of principal, and any products without market analysis or risk control plans will be prohibited.
Products involved in complicated financial derivative instruments or with exaggerated interest rates will also be banned.
Zhang Xuyang, general manager of China Everbright Bank's asset management department, said the CBRC's regulation is good for nurturing a balanced and effective risk culture among banks and investors.
"Banks' wealth management business will be more transparent. This is very important to guard against risks for the healthy and steady growth of the business," Zhang said.
Many banks plan to set up separate business departments at the head office level, while establishing a subsidiary company to independently manage wealth management business is also an option.
Economists have long worried that unregulated lenders have sold too many off-balance-sheet wealth management products that could default and set off a broader financial crisis.
The CBRC document also revealed that by the end of May this year, Chinese banks had sold 50,918 wealth management products with an outstanding book value of 13.97 trillion yuan (about 2.3 trillion U.S. dollars), equivalent to about 27 percent of China's GDP last year.
Such products brought Chinese residents more than 450 billion yuan in extra financial income at average weighted returns of 4.13 percent last year, well above the benchmark interest rate of 3 percent for one-year deposits, according to the CBRC.
Guo Tianyong, a bank researcher at the Central University of Finance and Economics, said the new regulation could end the "barbarian growth" of wealth management funds.
"By setting up an independent department, banks can prevent risks from spreading and serve their clients more professionally and efficiently," Guo said.
