Summary
The
growth of large online investment platforms has captured the attention
of Chinese authorities in recent months. Non-state enterprises such as
Alibaba Group Holding Ltd., which runs the e-commerce website Taobao,
and Tencent Holdings Ltd., a social media conglomerate that runs the
popular WeChat online messaging program, are an emerging force in
China's financial system.
The
question is whether these online financing platforms could start to
chip away at state-controlled banks' effective monopoly over the
country's vast pool of household and corporate savings. For now, funds
invested into new online financing platforms such as Alibaba's Yu'e Bao
are equivalent to a little more than 1 percent of the state-controlled
banking sector's roughly 74.2 trillion yuan ($12 trillion dollars) in
consumer deposits. But the platforms are growing rapidly.
Their
growth, and Beijing's official response to it, could affect the
trajectory of China's plans for financial sector reform. More
broadly, it could affect the country's financial and economic stability.
Analysis
Online
investment platforms offer attractive avenues for ordinary Chinese to
invest their personal wealth. They have been able to deliver high rates
of return (currently around 6 percent for Yu'e Bao and about 6.5 percent
for Licaitong, Tencent's competitor platform), and they allow
depositors to withdraw funds at any time, an option known as demand
deposit. Further, they are convenient to use because they are tied to
popular services such as Taobao and WeChat. These factors have made them
more attractive than smaller-scale online peer-to-peer lending
companies that have been active for several years but have recently run
into trouble due to borrower defaults.
Yu'e
Bao, the oldest and largest of these platforms, is less than one year
old. In just 300 days, it amassed 400 billion yuan ($70 billion) in
funds -- 150 billion yuan in the first two months of 2014 alone.
The
impressive growth rate of Yu'e Bao, and to a lesser extent its
competitors, will inevitably slow. As these companies become larger,
traditional banks will adapt and begin to compete, and eventually the
new platforms will saturate their core user bases. But with Internet use
in China developing rapidly, it is reasonable to expect that funds like
Yu'e Bao have ample space to grow right now.
Banks
in China have long enjoyed what many observers consider implicit
subsidies in the form of large spreads between the interest rates they
charge borrowers (most often state-owned enterprises) and the much lower
rates they pay depositors. This arrangement is underpinned by a system
of tight capital controls that leaves most ordinary Chinese with little
choice but to park their savings in a banks' coffers.
Several
avenues have emerged to fill this gap in recent years --
from investment in real estate to informal investment tools, including
wealth management products, categorized in China as shadow
lending. These paths are prohibitively expensive for most Chinese
consumers. More accessible investment options such as the stock market
are notoriously unstable. Depositors therefore keep their savings in
banks, where the rate of return is often lower than inflation. The
spread between interest and deposit rates has made China's largest banks
not only some of the world's wealthiest institutions but also key
pillars of Communist Party power -- and of economic stability in
general. This has been especially true in the years since the 2007-2008
global financial crisis, when the Chinese government turned to these
banks to keep China's economy churning by loosening credit to state-owned enterprises and local government financing vehicles.
Now,
banks face the prospect of real competition from sophisticated
investment platforms that harness the speed and reach of the Internet
and are operated by some of China's most competitive private
conglomerates.
Regulators Mull Their Response
Right
now, Yu'e Bao and its competitors remain effectively unregulated. The
only real constraint on their growth is the limits imposed by banks on
the amount of assets that can be digitally transferred from bank
accounts in a single day and a single month.
How
big these platforms get, and how quickly, will depend in large part on
the regulators' response. In recent weeks, China's central bank and its
top financial regulators have acknowledged the need for better
oversight. On Feb. 26, the China Securities Regulatory Commission said
it is mulling raising the minimum reserve requirement ratios of money
market funds. Currently these funds must hold 10 percent of their
balances in cash, but that could rise to an unspecified and probably
much higher ratio. Such a measure could blunt the growth of online
investment platforms by forcing them to either lower the yields promised
to depositors or to do away with demand deposit -- a major selling
point for the funds.
The
growth and lack of regulation over large-scale investment platforms
poses the most immediate risk to small and medium-sized banks. These
banks lack the enormous consumer deposit bases of China's so-called Big
Four state-owned banks -- the Industrial and Commercial Bank of China,
the China Construction Bank, the Bank of China and the Agricultural Bank
of China. The smaller banks will therefore be the first to feel the
pain of increased competition for deposits -- a competition that many
banks, constrained by the lack of a national reach, may lose.
Increased
competition for deposits is only part of the picture, however. The
online platforms invest the vast majority of their users' funds into
China's interbank money markets, on which cash-strapped small and
medium-sized banks increasingly depend to make their monthly and
quarterly payments. This means that China's small and medium-sized banks
are borrowing from platforms like Yu'e Bao even as they compete for
deposits with these same platforms.
Moreover,
given the rates of return promised to investors by the online financing
platforms, it is reasonable to assume that these platforms are lending
to banks at rates far higher than the Shanghai interbank overnight and
weekly averages. In some respects, the new platforms complement the
state-controlled banking sector: The platforms are providing much-needed
funds to banks. But this feeds a growing imbalance
between the state and informal banking systems. Local state-owned banks
across China are heavily and increasingly indebted to a range of
private and informal lenders that by definition remain largely outside
the purview of the state.
Increased
competition for deposits will also drive up the cost of capital for
state-owned enterprises, which traditionally have enjoyed
government-regulated low interest rates on loans. Internet financing
platforms are a small but growing element in the panoply of informal
investment and lending tools that have emerged in recent years as
byproducts of the state banking system's monopoly on formal credit. They
provide necessary liquidity to small and medium-sized enterprises, and
they do so outside the reach of state control. As these tools grow,
however, and especially if they compete on a larger scale with
state-owned banks for depositors, they will add to the pressure to
loosen controls on interest rates, bringing the rates more in line with
market forces.
This
will likely mean, at least temporarily, higher rates for the state
system's borrowers -- including many national champions in strategically
significant industries. The long-term fear is that China's state sector
-- which includes pillar industries like oil and gas, steel, cement, coal, power transmissions, transportation and logistics
-- could buckle under the weight of higher interest rates. Many of
these industries are already beset by troubles stemming from the
country's stimulus drive and its subsequent economic slowdown.
Changing Impact on the Economy
Finally,
there is the question of where the funds invested into these
platforms end up, and therefore what impact a crisis in the platforms
themselves might have on the rest of the economy. As noted above, at
present Yu'e Bao invests the vast majority of its funds into relatively
liquid assets like interbank markets, as well as corporate and
government bonds. Their immediate impact on the economy is thus
primarily to bolster interbank and banking system liquidity. But recent
reports suggest that a small but growing portion of Yu'e Bao's funds are
being channeled not to money markets, but to small enterprises, either
directly or indirectly. By mid-2013, Alibaba had disbursed at least $2
billion in loans to several hundred thousand merchants on its e-commerce
site, Taobao.
In
January, government authorities tentatively endorsed these and similar
activities by announcing a pilot plan to establish between three and
five private banks, with Tencent and Chinese electronics giant Suning
Appliance Co. Ltd. named as potential candidates. How widely and rapidly
this plan is implemented will depend, in part, on the continued success
and stability of platforms such as Yu'e Bao. At present, only some 2
percent of Alibaba's loans have soured, and the company cites its vast
trove of data on established Taobao merchants -- currently its only
borrowers -- as evidence that it can continue to effectively assess and
manage loan risk. Alibaba's management has made clear its intent to
expand the company's banking presence, but it remains to be seen how
regulators and China's powerful banks will respond.
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