It’s official: Internet finance is legal in China.
And it is more than just getting a legal status. It has won the heart of at least one top leader in Beijing. In his government work report delivered to the top legislature on March 5, Premier Li Keqiang said: “[We must] promote the healthy development of Internet finance.”
The mentioning of Internet finance effectively ends the doubt over its legality, in a strong demonstration that top policymakers are keen to leverage the power of the Internet to shatter the state monopoly of banks and press ahead with the reform in the financial system.
Internet finance industry emerged in China in the recent past with the rise of peer-to-peer lending websites, which offered a platform for individual or small businesses to get loans from retail investors. As small businesses traditionally found it difficult to get financing from banks, these websites turned out to be savior for small businesses.
However, regular banks didn’t feel any pinch from Internet finance at the time, mostly because those websites were small and their clients were not the traditional turf of regular banking.
Things changed last year, with another form of Internet finance, as represented by a product called Yu’e Bao, gained stellar popularity.
The product, launched by Internet giant Alibaba and fund manager Tian Hong Asset Management, sees Alibaba collect idle money from individual consumers for Tian Hong to invest in the money market. The product offers higher returns than regular bank deposits, and hence prompted many people to move their money from banks to the product.
Since it was launched in June 2013, it has attracted 81 million users, with aggregate deposits estimated at 500 billion yuan. Similar products were also offered by Baidu Inc and Tencent Holdings, two other Internet giants.
Most of the money raised by products like Yu’e Bao are re-invested in banks as contracted deposits, and thus allow depositors to enjoy a higher interest rate than regular deposits. What has made banks apprehensive is the fear that all of their regular deposits may become higher-rate contracted deposits and erode their advantage in attracting deposits at artificially low rates.
To tackle the competition, banks, even big state-owned national lenders, have increased their regular deposit rates to the upper end of the floating band, something they rarely did since the band was introduced.
Banks are apparently unhappy about this development, and have chosen to pin the blame on Internet finance, claiming that since the sector is outside the ambit of regulation it would lead to higher leverage levels and greater risks for the banking sector.
Whether these accusations are fair is open for debate, but one thing is without doubt. That is, Internet finance has shed light on the unreasonable existence of the dual-track interest rate system and banking monopoly.
China has two sets of interest rates. The first set of rates, controlled by the government, comes in the form of the deposit ceiling. The other is the set of interest rates determined by market players in a rather free manner.
Banks can attract deposits at a government-set annualized rate of about 3 percent, but fund managers have to raise money from investors at a market rate of about 8 percent. The gap means that banks, which already monopolize resources, can automatically enjoy an interest gap of 5 percentage points. They can lend the money to other lending agents such as fund managers to make net interest gains with ease.
Such a situation resulted in other market players having to pursue even higher return rates to stay afloat. With better and stable returns, the property market and government-backed fixed-asset investment projects naturally become the investment darlings. Since most of the credit went to these two sectors, asset bubbles and government debts ballooned, and left many small businesses and real-economy sectors in a lurch. What this meant was that small businesses would need to pay an interest of over 20 percent to get financing.
Products like Yu’e Bao, which enable moving of deposits within the banking system, have helped entities dodge the deposit rate ceiling and will pave the way for its ultimate removal, which many experts feel is the last step in China’s interest rate liberalization.
What’s more, the competition that Internet finance has brought to banks also shows the need to dismantle the banking monopoly by allowing diversified kinds of financial players to enter the banking industry.
But it is not to say that Internet finance can be free of regulation. The sector faces problems such as insufficient reserve requirements, poor information disclosure, lax management of funds, low entry threshold and rampant frauds.
Given this situation, it is no wonder that regulators are seeking out policies to govern the industry.
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