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Andy Yee: The need to tame Internet finance in China

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Alibaba Group Holding has increased China's financial inclusion through Internet lending.   © Reuters

For China's financial industry, 2015 will be remembered as marking a decisive shift toward the institutionalization of a diverse order. After several years in a regulatory vacuum, Internet finance companies came under proper supervision. This was in essence a formal recognition of Internet finance's important role in furthering financial reforms in China.

     Last July, with an unusual degree of coordination, 10 central government ministries jointly issued guidelines to promote Internet finance, providing for the first time a roadmap for comprehensive regulation and development. By the end of the year, the People's Bank of China and the China Banking Regulatory Commission had followed up with a flurry of regulatory documents relating to different activities in the sector.

     Leading Internet finance players like Alibaba Group Holding and Tencent Holdings publicly praised the regulatory certainty seen to come with these rules. Only two years ago, state banks had lobbied regulators to ban the companies' financial products. As China modernizes its anachronistic financial system in the digital age, reformers find Internet financiers to be fitting allies against established state banks.

     Internet finance in China must be viewed in the context of a system which remains dominated by banks. Under the country's "financial repression," funds have been funneled through state banks to support investments by state-owned enterprises and key export sectors. This mechanism was a linchpin of the East Asian developmental model pioneered by Japan, then South Korea and Taiwan, and now China.

     The model has been very successful, but it inevitably has become outdated. As nations progress to a higher stage of development, consumers and private enterprises supersede industry and investment. However, the former are usually neglected by state banks because of distorted interest rate incentives and the banks' long-standing links with SOEs.

     As a result, financial deregulation usually occurs long after it is needed. In Japan, reform delays led to two decades of financial malaise. Similarly, it took the 1997 Asian financial crisis and intervention by the International Monetary Fund to introduce reforms to South Korea that otherwise would not have occurred.

     Yet consumers and enterprises will find ways to evade controls. In Japan, South Korea and Taiwan, this took the form of nonbank financial institutions and curb markets. China's equivalent can be seen in the rise of shadow banking. The sector's assets are estimated to have grown to 46 trillion yuan ($7.07 trillion), or 80% of China's gross domestic product. While relatively small as a percentage of GDP compared with those of advanced economies, China's shadow banking sector is one of the largest in the world and is still rapidly growing.


What is special about China is that the rise of informal finance has coincided with the advent of Internet technology. The country's Internet service companies command huge user bases and hold voluminous data which can easily form the foundation of a credit system. This makes them well positioned to correct financial market imbalances. Recognizing the opportunity, Alibaba founder Jack Ma Yun said in a newspaper interview three years ago: "China's financial industry, especially the banking industry, only serves 20% of [potential] clients and I see 80% of clients aren't covered."

     Technology companies have indeed leveraged the Internet to quickly scale up and cover underserved segments. By 2014, over 60% of China's online population had made use of Internet financial products. One in six Chinese have invested in Yu'e Bao, a money market fund affiliated with Alibaba. This boosted the share of China's population with money in investment funds from 3% in 2012 to 12% in 2014. Leveraging its e-commerce prowess, Alibaba has also increased financial inclusion by providing over 400,000 small and medium-sized enterprises with loans of $3,000-$5,000.

     In the context of financial repression, a consensus is emerging that Internet finance has the potential to become a catalyst for reform and efficiency gains. Most Internet finance products are transparent and accessible relative to the rest of the shadow banking system. They can increase competition and help force the pace of more comprehensive reforms.

     This is not lost on China's reformers. Responding to initial calls from state banks to clamp down on financial products such as Yu'e Bao, central bank governor Zhou Xiaochuan stressed that the "use of technology" is encouraged in the financial sector. Seeing Internet finance-driven liberalization as almost inevitable, the attitude of banks toward the sector has changed from dismissive to active participation.

     This trend culminated in the official institutionalization of Internet finance in 2015. Although some may argue that the new regulations could stifle innovation, they are positive for the long term. The rules bring the new players under formal regulation and recognition. They will also give incumbents a chance to catch up. Looking ahead, it is important for China to achieve a balance between encouraging innovation and maintaining financial stability.

     In the second decade of the 21st century, the risk is that China is still looking to develop an economy with a 20th-century financial system. The time has come for China's banking sector to serve the broader society better.

     Internet financiers are an important driving force in this transition. Perhaps counterintuitively, a financial sector that is stimulated to become more efficient and consumer-oriented will eliminate much of the need for Internet finance in the first place.

Andy Yee is the public policy director for Visa for greater China and was previously with Google as an Asia-Pacific public policy analyst. This article expresses only the author's personal view.

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