Chinese Investment Scandal Highlights ‘Shadow Banking’ Risks

Typically marketed as low risk, these investments, known as wealth management products, offer tantalizing returns that seem to handily beat the interest rates that banks offer on regular accounts. Lured by the assurances of safety and promises of profit, investors have plowed their savings into the products.

But many of the investments have focused on coal, steel and real estate — areas that are facing overcapacity problems in China. As those areas show signs of trouble, the worry is that many of the investments could fail, creating a major shock to the Chinese economy, the world’s second-largest, after the United States’.

The products, which are often kept off banks’ balance sheets, are part of a vast, shadowy system of lending that has girded the Chinese economy and kept businesses growing. The Chinese government has stepped in to protect investors, avert ripple effects and ensure social stability.

But those bailouts create their own challenges. Investors, assured that the government will come to the rescue, do not worry about the potential risks and continue to pour money into the products. According to the state news media, Chinese investors have put $4.4 trillion into wealth management products, equivalent to about 40 percent of the country’s annual economic output.

“It invites moral hazard,” said Victor Shih, an associate professor at the University of California, San Diego, who specializes in the politics of Chinese banking policies. “When you tell people that they will get bailed out, then they will engage in very, very risky behavior and also opportunistic behavior on the part of the banks.”

China Minsheng, the bank at the heart of the latest scandal, had a good pitch.

The product, it told investors, would provide a return of 8 percent to 27 percent. To sweeten the deal, the bank offered free golf events and trips to South Africa and other overseas locales.

Encouraged by the bank’s strong reputation, investors, including many older people, forked over a minimum of $145,000. “My fund manager stressed again and again that there is no risk,” said Ms. Wang, the investor.

The scandal at China Minsheng erupted when a Chinese newspaper, the 21st Century Business Herald, reported on Tuesday that the bank’s wealth management product was forged and did “not exist.” The paper said more than 120 investors had registered to ask the bank to refund their investments and carry out an investigation.

The Chinese police have detained the head of the lender’s Hangtianqiao branch, Zhang Ying, the bank said in a statement to the Shanghai Stock Exchange on Tuesday. The bank said it was assisting the police with an investigation.

Investors gathered at the bank on Wednesday, pushing for the bank to make good. “We’re not going home if you don’t return us our money,” one of them shouted.

Such protests are a big concern for the government….

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