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Why mobile payments are worrying China's central bank

Alipay, WeChat Pay seen as weakening PBOC's grip on money supply

| China
The trend toward cashless payments in China, dominated by the country's big internet companies, could weaken central banks' hold over money supply.   © Reuters

For most Chinese officials, the sweeping trend toward the use of mobile phones to make payments is a point of pride in the nation's technological advancement.

For those at the nation's central bank charged with managing the financial system, however, the rapid rise of cashless payments is raising concerns over their grip on the country's money supply. The People's Bank of China's previous open-mindedness toward innovation is slipping, as seen by a burst of recent announcements that will see an effective floodgate put up between banks and the internet companies which provide mobile payment services. While the central bank's concerns are justified, hasty intervention could curtail the astounding pace of private-sector development of new services and technologies in the country.

Chinese have been abandoning the age-old habit of carrying cash at a rapid clip over the last few years thanks to the convenience of mobile payment tools. Through a mobile phone, one is able to complete all payments for everyday expenses, from hailing a taxi to ordering food from small vendors and paying for gas. It is no exaggeration to say that a cashless society has been taking shape in China.

There were 25.7 billion mobile payment transactions in China last year, 86% more than the previous year, according to official statistics. The total value of mobile payments amounted to 158 trillion yuan ($24 trillion), up 46%.

The rise in mobile payments has led to a remarkable deceleration in the growth in the amount of cash in circulation in China. Indeed, the growth rate of cash circulation has been running below that of the economy since 2014. For example, the volume of cash in circulation grew 6.4% last year while the economy expanded 6.7%.

The phenomenon is quite unusual as the growth of cash demand has generally exceeded aggregate output expansion ever since China started publishing these statistics in the late 1990s. It shows how mobile payment tools have been taking place of cash as a medium of exchange in the economy.

The mobile payment market in China is dominated by a few large internet companies, namely Alibaba Group Holding affiliate Ant Financial Services Group and Tencent Holdings. Alipay and WeChat Pay, their respective flagship payment services, have market shares of 54% and 40% respectively.

Their leading position stems in part from the two companies' ability to offer value-added services to mobile payment users which extend their advantages over cash. For example, Ant Financial offers a money-market fund called Yu'e Bao to its users so that they can earn interest on balances in their payment accounts.

The internet companies have been seeking to export their mobile payment businesses to other countries. As a first step, Ant Financial has been building relationships with foreign banks to enable Chinese tourists to make mobile payments abroad. In the long term, these companies could build a global network for mobile payment that not only caters to the demands of Chinese tourists but also serves the residents of other countries.

Mixed feelings

In theory, financial regulators, in particular central bankers, should welcome the cashless trend as it mitigates problems related to heavy cash use such as corruption and tax evasion. Moreover, a central bank can also benefit from cost-savings related to printing, storing and circulating currency notes.

However, as the mobile payments trend gathers pace, the PBOC has found that a real cashless society raises a number of challenges.

First, a central bank's control of the monetary system comes through its payment clearing platform for banks. As such, a central bank can gather information regarding interbank payments and use that to formulate and implement policy.

Small payments settled in cash have long been out of the scope of the bank clearing system. To some extent, central bankers could overlook this due to technical difficulties in tracing such transactions. More importantly, central bankers did not have reason to believe any other individual or institution was able to systematically trace these cash-related transactions or influence them.

However, the cashless trend could change central banks' supremacy in the clearing system. Under the current business model of mobile payments, Ant Financial and Tencent act as middlemen between customers and banks to complete money transfers from one account to another.

As a consequence, these internet companies now have full control of all information regarding customers' mobile payment transactions. To a certain extent, internet companies seem to have established an independent clearing system for small transactions in parallel to the interbank clearing system controlled by the central bank. Internet companies could use such information and influence consumer behavior to their own advantage. The PBOC naturally cannot tolerate being sidelined in this area.

Some value-added services provided by internet companies could also pose a threat to financial stability. The most conspicuous example is Yu'e Bao, which has become the world's largest money market fund and held 1.43 trillion yuan as of June 30. Its holdings alone account for 28% of the total value of China's money market funds.

It is now a big whale in a small pond. Any movement by Yu'e Bao could lead to turmoil in China's money market and destabilize the financial system. Apart from enhancing its supervision, the central bank is seeking a tighter grip over this whale to ensure that it won't thrash the pond. The regulators have recently announced new requirements that will require money market funds to deposit more reserves into accounts at the central bank and limit investment in high-risk assets.

The cashless trend could also make it more difficult for the central bank to monitor capital flows across borders. Since the unexpected devaluation of the yuan in August 2015, China's central bank has battled various forms of disguised capital outflows to avert a vicious cycle of capital flight and currency depreciation. However, the global strategy of the major internet companies could make it harder for China to plug holes in its capital controls.

Under the PBOC's mid-August directive, banks and online payment systems offered by internet companies must connect to a new clearing platform called China Nets Union Clearing so that all mobile payment transactions can be conducted through it from next June 30.

Ultimately, the cost of tight control over mobile payments could be high. Both Ant Financial and Tencent have invested heavily to build relations with banks to build up their own payment platforms. The establishment of China Nets Union has completely destroyed the value of their existing platforms and erased this advantage over new players in the mobile payment market.

This could disincentivize internet companies from innovating and slow their investment in financial technology. Even smaller players who could benefit from the new clearing platform will need to think twice before making large investments in their own brilliant ideas.

Xia Le is chief economist for Asia at BBVA Research. He is also a research fellow with the International Monetary Institute at Renmin University of China.

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