China’s internet banking faces tightened regulations

China’s internet banking faces tightened regulations

China’s central bank is considering regulations that would curb the development of China’s internet banking innovation. Facing rising domestic financial risks, Chinese policy makers seem to be liberalizing the financial market with great caution.

On 13 March 2014, China’s central bank, PBOC, suspended the use of payments made by scanning two-dimensional codes with mobile devices and halted the issuance of new virtual credit cards by Tencent and Alibaba, two Chinese Internet giants with their own online payment arms.

According to PBOC, this was done to protect consumers from any security glitches in such third-party payment systems.

China’s internet banking sector has grown so fast in the past year that the state has had to intervene and regulate the market. China’s online and mobile payment transactions have been growing frenetically. The online payment market increased 42 percent to $1.2 trillion in transactions in 2013.

Yet the more fundamental development in China’s internet banking sector is the burgeoning financial services, such as wealth management products, provided by companies like Alibaba and Tencent.

Users of these Internet companies’ payment platforms can buy wealth management products using leftover money in their payment accounts. Internet companies thus become intermediaries between individual investors and funds, often channeling investors’ money from their bank accounts to investment funds.

Alibaba introduced the high-yield Yu’e Bao money market fund managed by Tianhong Asset Management Co., Ltd. eight months ago. Since then, tens of millions of people have flocked to internet companies’ wealth management products, attracted by returns that are 15 times higher than those allowed on conventional deposit accounts at regulated banks.

Yu’e Bao MMF alone has attracted RMB 400 billion assets under management, more than the customer deposits held by the five smallest listed Chinese banks.

The rampant growth of Internet companies’ funds poses substantial challenge to China’s commercial banks. The story is more complicated than internet companies diverting deposits from commercial banks and giving them to funds. In fact, most of the deposits channeled from commercial banks to funds through online platforms eventually flows back to the banks, as they were invested in negotiated deposits offered by the banks.

The growth of internet banking not only hurt banks’ deposit volume, but also raised banks’ borrowing costs, as negotiated deposits generate high yields for investors.

Although UBS calculated that one tenth of bank deposits fleeing to online products might cut the net interest margin at banks by just 0.1 percent, Chinese regulators, urged by state-owned banks, decided to intervene.

PBOC recently released draft rules that would limit spending by individuals using third-party payment platforms and transfers from bank accounts to accounts managed by third-party companies. The draft rules are still under consultation with banks and Internet companies.

Meanwhile, three state-owned banks have halted interbank deposit transactions with Alibaba’s partner, the Tianhong fund, due to high costs.

Despite the apparent need to regulate China’s internet banking, it is an art to find a balance between stability and financial market liberalization. China’s state corporations have relied on cheap bank loans for years, subsidized by Chinese depositors.

The popularity of internet companies’ funds is mainly built on people’s need for better alternatives to low-yield bank deposits. Supporting financial innovations equates to supporting liberalizing China’s financial market.

However, given high corporate and local government debts, sluggish economic performance in Q1 2014, and the recent local bank run and bond default, a full charge at liberalization could fuel a credit bubble and increase risk.

Categories: Asia Pacific, Finance

About Author

Roger Yu Du

Roger works for a strategic advisory group that provides services to investors focused on Asia. He holds a master’s in International Political Economy from the London School of Economics and received his BA in International Relations from Fudan University in China, with a focus on East Asian affairs.