There’s a price to pay for size.
And when you’re growing like Alibaba’s Yu’E Bao online money market fund, you’re liable to brush up against a wall. That wall would be the price you pay to keep growing.
Here is the problem: Yu’E Bao can’t keep growing and keep paying high interest at the same time. Sooner or later, something has to give.
“It’s easy to produce lucrative margins when you’re smaller. But as you get bigger, you become no different from everybody else in terms of your interest profile,” Keith Pogson, a senior partner of financial services for Asia Pacific at Ernst & Young, told EJ Insight.
Yu’E Bao’s aggregate deposit of 500 billion yuan (US$80.50 billion) is small compared with those of China’s big four commercial banks which hold 10 trillion yuan each.
If you have an investment that big, you’d have to lower your interest rates or your returns will drop, Pogson said.
“It’s kind of difficult [for Yu'E Bao] to keep rates above 6 percent as they are at the moment.”
Through Yu’E Bao, which is operated by Tian Hong Asset Management, Alibaba collects idle cash from individual consumers and invests it in the money market.
The product offers higher returns than a regular bank deposit, prompting bank account holders to switch their funds.
Since its launch in June 2013, 81 million investors have parked an estimated 500 billion yuan in Yu’E Bao accounts.
This explosive growth has sparked controversy, with vested interests in the banking sector condemning the product for distorting interest rates. They want Yu’E Bao to be subject to deposit reserve regulations.
Internet finance products should be required to comply with reserve and capital thresholds to better protect investors, Pogson said.
“People get into a sort of herd mentality around some particular trends. Speculation, stock exchange, IPO launch — call it whatever you want — and investors tend to all walk together in the same direction,” he said.
“It is difficult to see how default risks would be shared by participants of the scheme.”
Reserves offer more stability in the scheme by serving as a buffer. Setting aside capital is a sensible requirement in order to manage losses should they occur, Pogson said.
At its present size, Yu’E Bao could offer interest rates at 4.5 percent even if it is required to maintain reserve and capital ratios similar to banks.
It’s a pretty good return for investors compared with just over 3 percent offered by traditional banks for long-term deposits. If state banks are paying 4.5 percent interest, their profits will be greatly diminished, probably by about 65 percent to 75 percent, Pogson said.
China requires commercial banks to set aside 21 percent of their deposits and maintain a certain capital adequacy ratio. At the end of December, that ratio was 12.19 percent, according to Bloomberg.
A very different future
“Banks need to serve you in a way you want to be served and become more connected to your lifestyle,” Pogson said.
“Your salary is paid into your bank account. Then banks try to convince you not to take it out and use their services instead of putting the money into Yu’e Bao,” he said.
“They try to convince you to use their payment network and wealth management services and put your pension account with them.”
Ultimately, however, banks will become “very much like a technology company as well”, and this transformation is going to come at great cost.
In its Global Consumer Banking Survey of 32,000 customers in 43 markets, Ernst & Young found that nearly half of the respondents use ATMs and internet banking services at least once a week. A third use mobile banking once a week but only one quarter will visit a bank.
That means the cost of serving bank customers will become increasingly prohibitive. Much of the money will go into securing data and guarding against cyber attacks, Pogson said.
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