Wealth management products (WMPs) in China are set to attract inflows of Rmb10 trillion to 15 trillion ($1.7 to $2.55 trillion) from bank deposits over the next two years, due to the higher returns offer by such instruments, predicts UBS’s head of China equity strategy.

WMPs, which invest in bonds and money market funds, will offer returns of 4.5% to 5% in the next two years, said Chen Li, speaking at a conference in Shanghai this week. Chinese individuals have Rmb40 trillion ($6.6 trillion) in savings, while investment in WMPs stands at Rmb10 trillion.

The cost to the bank of a deposit is 1.2%, Chen says, and the outflow from deposits into WMPs will increase that cost to 2-2.2%. This is because banks – which need deposits to run their business – must pay more to absorb deposit costs to compete with WMPs.

As a result of Chinese interest rates normalising – after being allowed to be set by the market – mainland commercial banks’ net interest margins and profit margins will come under pressure, says Chen.

To offset the increasing costs of deposits, banks previously invested them into non-standard assets (such as credit loans, trust loans, acceptance bills or letters of credit) to generate returns, or raised loan rates. But banks’ ability to increase loan rates is now more limited.

Chen says 2014 will mark the first year that mainland commercial banks will post only single-digit growth, and argues that some may even suffer negative growth next year. “The increasing cost of absorbing deposits will come as loan rates cannot rise any more.”

Meanwhile, the re-opening of China’s IPO market is one of the biggest downside risks for China stocks this year, argues Chen. This is because it will divert capital from secondary markets such as ChiNext, the mainland market for start-ups.

UBS forecasts that the country’s previously dormant primary equity market – closed since October 2012 – will raise Rmb500 billion this year, with IPO issuance to peak at 60 to 80 per month between March and June. As a result, ChiNext, which has high valuations at the moment, Chen says, will see a correction after March. 

Earnings-per-share growth for A-shares will be 11.5% this year, he adds, largely due to the country’s GDP growth, forecast by UBS to be 7.8% for 2014. Rising interest rates are likely to limit the the rise in the CSI 300 Index to 10-12%, says Chen.

Sector-wise, UBS is underweight capital-intensive industries and cyclical A-shares. It is overweight the sewage disposal industry, light-emitting diode (LED) companies, railway equipment firms, medical device manufacturers and some casual clothing companies.