17 October 2019
Alibaba, led by Jack Ma, has been tapping into internet finance demand in China following the launch of the group's Yuebao services. Photo: Bloomberg
Alibaba, led by Jack Ma, has been tapping into internet finance demand in China following the launch of the group's Yuebao services. Photo: Bloomberg

Why regulation needs to catch up with internet finance

Premier Li Keqiang introduced a new “Internet Plus” policy during the annual parliamentary sessions in March. And professionals from various sectors have discussed the issue of transforming traditional business with internet technology. In all the deliberations, internet finance has been a hot topic.

China has been in the frontline of internet finance development. The nation’s first peer-to-peer or P2P loan site, PaiPaiDai, came into place many years ago, in 2007.

There are now more than 1,500 active P2P lending firms across the country. And internet giants like Alibaba, Tencent, Baidu all have expanded their presence into finance services through online lending, payment and wealth management.

Alibaba launched its online mutual fund Yuebao and attracted nearly 600 billion yuan into its money fund within one year. Now the fund ranks the biggest among the kind in China and the third largest in the world.

The nation’s internet finance is very likely to surpass that of developed economies.

Internet technology has been widely used in various industries and sectors in China. As a unified market with same history, traditions, language and culture, China is the fertile ground for developing internet technology.

For example, online shopping sites like Taobao and Jingdong have already snapped up substantial share of the retail market thanks to internet technology.

The e-commerce development would demand relevant financial services. Most online retailers do not have real-assets shops or inventory as the offline rivals; therefore, it’s very difficult for them to get credit from traditional financial institutions like banks who usually requite hard assets as collateral.

Alibaba launched its own lending platform, Aliloan, which extends loans to online vendors based on their trading records and customer ratings. Also, Alipay has tackled the issue of the counter-party risk in online transactions, while Yuebao has fixed the return of remaining funds.

However, China’s financial regulation has lagged far behind in terms of long-term cap on interest rate and entry threshold for financial institutions. 

The rampant growth of wealth management and trust products reflected innovations to get around the interest-rate cap. The entry threshold imposed on financial institutions have created dominating state-owned big banks, who focus on serving big companies while neglecting vast majority of small and micro firms and rural customers.

That has given rise to social financing. And the online format of P2P and cloud-funding is in essence social financing utilizing internet platforms.

Chinese financial regulators have basically adopted a “let-go’ approach in internet finance sector. The industry has grown rampantly with no regulation, guidance or criteria. That could pose potential risk for financial stability.

For example, a number of P2P platforms supply creditors with own capital, and hold until investors join. Or some platforms would bundle different loans and repackage and sell them to investors, in another form of wealth management products.

Various platforms have pledged to guarantee principal payment for investors. However, some of these P2P websites may grapple with credit crunch once any project payment has been delayed or defaulted.

Cloud-funding platforms work in similar way to fund-raising through IPO, and these platforms could easily facilitate illegal fund-raising without any supervision.

Internet finance has filled in a gap in China‘s financial system and pushed financial reform. However, it also bring potential risks for both investors and the broad financial system.

This article, published in the Hong Kong Economic Journal on May 6, was contributed by Frank Song Ming, who is the founding director of the Centre for China Financial Research at the University of Hong Kong.

Translation by Julie zhu

[Chinese version中文版]

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