19 March 2019
China's central bank has to keep the regulatory mechanism in pace with internet finance. Photo: Bloomberg
China's central bank has to keep the regulatory mechanism in pace with internet finance. Photo: Bloomberg

Internet finance: Challenges and opportunities

Yu’e Bao is now China’s hottest online “piggy bank”. Founded in mid-June 2013, it is an online money market fund (MMF) promoted by e-commerce giant Alibaba and offered through Tianhong Asset Management. It offers daily settlement of transactions and pays annualized interest returns of more than 6 percent (versus around 3 percent for time deposits).

High and rising yield since July 2013 is the key factor that has drawn billions of yuan into Yu’e Bao from millions of investors. It raised 100 billion yuan within six months of inception, and its assets under management (AUM) have now surpassed 400 billion yuan.

The success of Yu’e Bao has also fueled the growth of China’s money market fund sector, sending its AUM to over 1 trillion yuan from 304 billion yuan between June 2013 and February 2014. MMF segment now accounts for a third of the total AUM of China’s mutual fund sector. Other internet companies, notably Alibaba’s major competitor Tencent (which offers Caifutong), and banks (which offer wealth management products linked to MMFs) have jumped onto the bandwagon.

What makes Yu’e Bao and the likes so feverishly successful is the combination of interest rate liberalization and financial innovation. A policy shift by the People’s Bank of China (PBoC) from complete control towards more market-orientation on the back of a tight monetary bias has pushed up China’s interbank interest rates, quite sharply (to over 10 percent on an annualized basis) at times. Yields of Yu’e Bao have surged along since 90 percent of the funds come from negotiated deposits, which are not subject to interest rate controls.

On the other hand, bank deposit interest rates remain regulated with a rate cap of 10 percent over the official benchmark rates, thus depriving the banks of the ability to compete with Yu’e Bao’s high-yield products. Yu’e Bao’s innovation is that it has combined high yields with prefect liquidity of daily settlement.

Like the emergence of trust and wealth management (WM) products, the rapid rise of Yu’e Bao has increased the pressure for interest rate liberalization by eschewing government interest rate controls. It has also augmented the impact of the trust and WM products on breaking the monopolistic power of the Chinese banks and encouraging financial innovations. But Yu’e Bao and the likes are the first of their kind in fostering the development of internet finance.

The Yu’e Bao “fever” that emerges on the back of the lack of sufficient regulatory control is not a reason for shutting it down, as internet finance is a natural course of financial development. Rather, it highlights the urgent need for Beijing to improve systemic risk management. Regulations and supervision should move quickly to manage the emerging risks associated with Yu’e Bao and the likes.

One approach is to establish a joint supervisory committee involving the PBoC, the China Securities Regulatory Commission (CSRC), the China Banking Regulatory Commission (CBRC), the China Insurance Regulatory Commission (CIRC), and the Ministry of Industry and Information Technology (MIIT) for comprehensive cross-board supervision.

A proper due diligence process, both at the industry and regulatory levels, should be installed to minimize the potential risk of misconduct. Capital requirements for the internet finance players should be clearly defined and established. The current loss provision requirements for MMFs (at 10 percent of accrued management fee with a cap of 1 percent of AUM) are too low. They should be raised to discourage excessive risk-taking behavior and cut-throat competition.

However, in China’s regulatory environment, the biggest challenge is implementation. The CSRC had already published a regulatory guideline in 2011 that requires loss provisions of mutual funds to cover 200 percent of accrued interest, but it has never been implemented. So improving regulatory implementation is imperative for improving systemic risk management.

Besides loss provisions, the authorities should impose penalties on the players who break their negotiable deposits before maturity, just like the banks do to their customers who break their term deposits. This is to ensure stability of the banking system and to encourage prudent practice of liquidity management by the players.

On the user side, China needs to establish urgently a regulatory framework for consumer protection to clearly define the responsibilities of the various service/product providers in internet finance. It should include proper and full disclosure of product information, structure and returns and risks, and building an arbitration process for disputes.

From a macro perspective, the rapid growth of internet finance is another means of interest rate liberalization by stealth. It adds pressure on the authorities to speed up the liberalization process and forces the banks to operate more efficiently by breaking their long-held monopoly.

The PBoC will have to find new benchmark rates (to replace bank deposit rates) and new monetary aggregates (to include internet finance) for conducting monetary policy. In a nutshell, the rise of internet finance is initiating revolutionary changes in China’s financial landscape, bringing both risks and opportunities to the Chinese consumers.

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Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

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