The Growth of Internet Financing:

A Positive Financial Innovation for

China’s Shadow Banking Industry?

Lesson 5: The Constraints and Future of the Chinese Economy

Background
Whilst the coverage of the Chinese financial system has predominantly been centred around the exponential
growth, the unexpected dangers of shadow banking and the state’s unproductive investments that have arisen
from purposed indiscriminate financing, we would like to highlight to the reader on the growing trends of internet
financing (a form of shadow banking) in China. Today, this is an increasingly important topic seen by observers as a
key disruptive force that will help to push for accelerated financial innovation amongst the state-owned
incumbents/financial innovations.

Purpose
Informal financing is seen by some as a “pro-growth” institution that can contribute to financial deepening. In
particular, we would like to establish if the growth of the internet banking platform, that is led by the rapidly
growing technology-focused conglomerates, i.e. Alibaba, Tencents etc. would help jolt the stable of currently
contented, state-controlled commercial banks, “Big Four Pandas 1” into action, to compete for market share of
depositors fund and the lending business 2. It is also hoped that the increase in healthy competition within the
financial sector would result in benefiting the end-consumers and economy as a whole.

A genuine disruptor or not?

The successful launch of China’s very first online-money market fund Yu’e Bao 余额宝 in June 2013 took many
investors and the regulatory authorities by surprise. 余 额 宝 meaning “leftover treasure,” is a complimentary
online money fund that is offered through the Chinese e-commerce giant Alibaba Group Holding Ltd.'s third-party
payment affiliate, Alipay.com and managed by a third-party fund manager, Tianhong Asset Management. The
financial lies in the simple idea of having idle cash in Alipay balances be used to buy into the money market fund
with a minimum investment of just one yuan and holdings can be redeemed anytime to pay for online purchases.
Individual buyers and business suppliers can make use of these services, without discrimination.

As of June 2014, the fund has reportedly attracted about Rmb 574 billion ($93 billion) in assets from 150 million
investors. Yu’e Bao is seen as a “new generation” of online wealth management products that offers simplicity and
convenience at the click of just a button, offering a very valuable proposition to the estimated Rmb 100 trillion
($16.2 trillion) in deposits that sit relatively idly in Chinese banks today. Traditional banks can only offer depositors
a maximum of 3.3% for a 1-year fixed deposit, to abide with regulations set by PBOC, vis-à-vis to Yu’e Bao who
have offered an annualised “6%”for 2014. Readers may wish to note that the interest offered by Yu’e Bao is not
guaranteed and Yu’e Bao’s operation is not overseen by the financial authorities, as its financing activities are seen
as part of the larger shadow banking landscape. The commercial state-owned bank has been campaigning to the
banking regulatory authority of China for these online money market fund to be subjected to the same banking
supervision rules which demonstrates to us the fear of the incumbents of the prowess of the nimble disrupting
internet giants, who have decided to have a slice of the lucrative banking sector.

Power to the people. Inequality be damned.

In response to Yu’e Bao’s phenomenal success, other internet companies have been collaborating with fund
management companies to rollout similar innovative products by the droves, e.g. Baidu launched its Baifu fund in
December 2013 and Wechat launched its Licaitong in Jan 20143. This has brought about 3 major benefits to the
Chinese community who can enjoy these benefits as long as they have mobile internet access.

1. The minimum investment amount for publicly offered funds was typically set as 1,000 yuan. By lowering
the investment amount to 1 yuan, these new online wealth management products have made money
market funds more accessible to the masses. Investment is not just for the well-to-do anymore.

2. These money market fund are not channelling financing towards the property or commodity industry
players, hence they are not the usual wealth management product suspect, in which the promised
returns are to be doubted. Instead, they do offer the common man on the street a way to tap and secure
paid interest via the usually high inter-bank lending rates in China.

3. To compliment Yu’e Bao’s, Alibaba also set up an online peer-to-peer(P2P) lending investment product,
Zhao Cai Bao in April 2014, helping aggregate funds of small time investor to meet genuine financing
1
The "big four" state-owned commercial banks are the Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China and the
Agricultural Bank of China
2
China’s Funds Could Threaten Bank Business in 3 Years. The Wall Street Journal China. http://blogs.wsj.com/chinarealtime/2014/02/28/chinas-funds-could-
threaten-bank-business-in-3-years/ Accessed 13th Feb 14.
3
Text, Chat, Profit: Tencent Launches Investing on WeChat. The Wall Street Journal China http://blogs.wsj.com/chinarealtime/2014/01/22/text-chat-profit-tencent-
launches-investing-on-wechat/ Accessed 13th Feb 14
 needs for SMEs, in which the riskiness of loan repayment will be jointly underwritten by financial
institutions such as Ping An Bank Co. etc. 4 To tackle information asymmetry, Alibaba is also able to
leverage on its in-house technology to aggregate payment data in helping lenders assess credit-
worthiness of borrower5.

The above innovations will be very helpful to fuel the growth of the economy as the contribution of smaller SMEs
production to China’s GDP figures accounts for an estimated 60%-65% but they often struggle to obtain loans from
state-owned banks. Through the building of an intermediation platform whether through Yu’e Bao’s or Zhao Cai
Bao, Alibaba is creating a vital and even better, cheaper credit lines for SMEs to finance real economic activities,
whilst allowing common investors to earn safer higher returns, so they will not have to just rely on traditional
property investments(which have been toppish and sluggish in recent times), WMPs (ponzi scheme about to be
unravelled?) and equity investing (legalised casino with volatile returns 6)

Financial Reform: Risk prevention and regulatory oversight

CPC appears to have given the green light to push on with rapid financial reforms, unveiled at the Third Plenum of
the Communist Party in November 2013. Premier Li Keqiang pledged that he would “promote the healthy
development of Internet banking” and PBOC has called internet financing a beneficial complement to current
financial system… help improve financial efficiency through different channels than traditional finance. 7

Just last month, Chinese Premier Li Ke Qiang officiated the launch of WeBank, which reflected the government’s
hope that a new crop of privately owned lenders will expand access to finance for small-scale borrowers. WeBank
is a joint venture led by Chinese gaming and social network group Tencent Holdings which became the first private
bank to start operations under a pilot, after the banking regulator granted licences to six such institutions last
year8. Alibaba, as one of the six institutions will partner with Fosun International, one of China’s largest private
conglomerates, to form Zhejiang Internet Commerce Bank. These recent developments highlight to us the
government’s clear intention to allow for the deepening of financial reform.

Political and International Implications: The China Nationalistic Pride

It is my hypothesis that the welcoming in the entrant of non-financial institutions into the banking sector is also a
political move by the CPC, to warn existing incumbents not to take their current appointed roles for granted and
secondly as we now can see how Alibaba is proudly flying the China National Flag up high in international markets,
made evident by the recent IPO offering led by the visionary Jack Ma to claim the title of the largest global IPO
ever.9 Alibaba and Jack Ma are now seen as the poster child to inspire aspiring private entrepreneurs and awaken
sluggish SOEs to pull up their socks, to intensify the business competition. Also, by allowing Alibaba to slowly
become a success on the home ground and by CPC’s willingness to work with the organisation to iron out
regulatory requirements, the CPC is sending a signal to other governments worldwide to also declare for a joint
implicit support for Alibaba’s product and services to be accepted as part of their business economy. An example
is seen in Alibaba’s recent strategic partnership with the listed Lending Club, a leading U.S. lending marketplace, to
make working capital available to millions of U.S. small businesses that source inventory from China 10. Also, I note
that Alibaba is also attempting to bring Yu’e Bao’s into the Hong Kong asset management industry as well 11.

With proper management and close supervisory oversight of the financial regulatory authorities, the path
dependency route of the technology giants in pushing for a more rapid financial deepening of the system looks set
to continue and barring any serious external shocks, this will likely be beneficial for the Chinese economy as a
whole. Also the gradualist approach undertaken by CPC, e.g. pilot projects to give private banking licences will help
minimise and mitigate risks to the economy. Lastly, an ironic outcome is that since shadow banking is now made
“official” and part of the light now, as transactions are conducted online and is deemed track-able, it may be

4
Alibaba Platform Set to Dominate P2P Lending Scene? http://www.altfi.com/globalnews/445. Accessed 13th Feb 14
5
Alibaba finance arm sets up China consumer credit-scoring system http://www.todayonline.com/business/alibaba-finance-arm-sets-china-consumer-credit-
scoring-system Accessed 13th Feb 14
6
Personal observations of Prof Chung Wai Keung on 9th February 15
7
China Monetary Policy Report Quarter Two, 2013. The report noted a number of advantages of internet finances, including greater transparency, broader
participation, lower intermediation costs and faster payment processing.
8
Tencent launches China’s first online-only bankhttp://www.ft.com/intl/cms/s/0/ccc5a6dc-9488-11e4-82c7-00144feabdc0.html#axzz3Rjz4cl00 Accessed 13th Feb14
9
Alibaba Claims Title For Largest Global IPO Ever With Extra Share Sales. http://www.forbes.com/sites/ryanmac/2014/09/22/alibaba-claims-title-for-largest-global-
ipo-ever-with-extra-share-sales/. Accessed 13th Feb 2014
10
Lending Club, Alibaba.com Offer Financing to U.S. Businesses http://www.alizila.com/lending-club-alibabacom-offer-financing-us-businessesAccessed 13th Feb 14
11
Yu’e Bao’s bid for HK market ‘won’t be smooth sailing’http://www.chinadailyasia.com/hknews/2014-10/15/content_15177898.html Accessed 13th Feb 14
inadvertently easier for government to monitor the industry now but that might create another set of regulatory
institutional problems.