China’s Internet Banking Revolution

The Internet in China has started to force real change on once-staid banks, forcing well-fed bankers to cough up better deals on yields on cash deposits that conventionally have been a given under the existing suppressed deposit rate regime.

Even though commercial banks have started instituting countermeasures by offering money market funds as well as e-banking platforms, they remain on the defensive and the battle is about to extend into the field of term deposits when Alibaba’s Alipay launches a 12-month, 7 percent anticipated-yield investment product Friday that also protects principal.

The deal is exclusive to Yuebao account holders who register ahead of time for the online bidding at 10:00AM the 14th. More than 1.3 mn users have already signed up and the number is climbing rapidly.

The only catch preventing an overnight exodus of the RMB46.1 trillion in household bank deposits towards such juicy online deals is of course, their limited availability, but the emerging trend of households placing less cash with banks has been firmly in place since last October. Issuance of this one-year wealth management product is reported to be just RMB300 million according to Securities Times.

China’s banking scene has been undergoing wrenching change over the past two years, with a whole variety of new instruments and institutions shaking up the financial system. The shadow banking sector has been growing at a torrid 34 percent rate since 2010. Government leaders recognize that they can’t turn back the clock to a state-owned system, but their approach is to attempt to control the risk while seeking to make the system more efficient.

Into this has come the Internet. Initially envisioned by the Chinese ecommerce group as merely a way for its users to manage funds in their online payment accounts, the Internet operations have instead mutated into what amounts to a full-blown surrogate for traditional deposit-taking operations.

The revolutionary Yuebao – translated as “found treasure,” from Alipay already surpassed RMB250 billion in funds last month. Despite the fact that flagship money market funds from Alibaba and Tencent have seen yields falling sharply after the end of the Lunar New Year celebrations as Shanghai interbank offer rates are tamed, aggressive marketing campaigns and the strong willpower to turn brick-and-mortar banks upside down characterize China’s online warriors. Creative disruptions to the traditional banking sector will increase, not fade, in the coming year.

Internet money market funds advertise annualized yields based on performance of the preceding seven days, and the two leading players Yuebao and Licaitong have been churning out returns beyond the benchmark Shanghai Interbank offer rate. The question many have is: how do these emerging online vehicles make more money than the old model? For a start, their nimble stance allows the fund managers to take advantage of the spikes in interbank rates last year and ahead of the Lunar New Year. Second, online-only platforms are effective in reducing the cost of doing business – no need for physical branches, check-processing equipment, and of course personnel. Lastly, razor-thin management fees of 0.30% and lower are likely to have boosted their realized returns.

Money market funds are hardly new in China, having been around since October 2003. After a few strong initial years, the segment shrank and stagnated to under RMB200 billion. Banks have generally been reluctant to push these products in the past as they have not been incentivized to offer depositors extra yields on what is essentially interbank risk premium. Selling more would have only increased their cost of funding. However, the combination of tighter interbank rates since last June and the timely debut of Alibaba’s Yuebao in May last year reinvigorated the sector. Their success online originates from the unique mix of instant cash availability akin to a bank savings account at never-before-seen yields and the freedom to cherry-pick the best returns anywhere with mobile connectivity.

Money Market Funds in China Legends: *Number of Funds (RHS) *AUM

China Asset Management’s Qu Bo, who manages Tencent’s popular Licaitong wealth management product with AUM over RMB100 billion, expects the internet to be the key to help the sector break its previous growth bottleneck. China’s money market funds now manage over RMB900 billion, up 2.5x from previous May. Given China’s interbank borrowing volume of RMB35.5 trn in 2013, that makes a RMB2 trn sector AUM by end-2014 an easy layup given their popularity among China’s 600 mn netizens, leaving equity and fixed-income funds far in the rearview mirror. At those level, that still translates to just 4% of estimated household bank savings by December.

Categories Number % NAV (RMB billion) % Equity Funds 617 38.7 10,043 33.9 Neutral 372 23.4 7,185 24.2 Passive 210 13.2 2,480 8.4 Aggressive 35 2.2 378 1.3 Hybrid Funds 236 14.8 5,280 17.8 Equity-leaned 172 10.8 3,986 13.4 Balanced 36 2.3 1,038 3.5 Bond-leaned 28 1.8 257 0.9 Bond Funds 395 24.8 3,059 10.3 Mid-to-long Term 156 9.8 1,430 4.8 Short Term 9 0.6 59 0.2 Hybrid Class 1 106 6.7 870 2.9 Hybrid Class 2 124 7.8 700 2.4 Money Market Funds 156 9.8 9,105 30.7 Other Funds 275 17.3 2,791 9.4 Redemption-Guaranteed 55 3.5 589 2.0 Closed-End 136 8.5 1,629 5.5 QDII 84 5.3 573 1.9 Total 1,593 100.0 29,658 100.0 Source: Wind *Equity Focused/ Fixed-Income Focused

At the bottom line, the size of the money market funds isn't as important as their function: in the United States, they forced the elimination of the government deposit ceiling on passbook savings accounts (Regulation Q) in the early 1980s, which basically destroyed the savings and loan industry. Banks had to bid for funds at market rates rather than obtain cheap funds from savers at artificially fixed rates.

Alibaba and its peer competitors could very well consider running their own banks and brokerage companies and vertically integrate. They could also sell insurance products online. That logic could make the smaller banks and brokers may be acquisition targets.

(Steve Wang is chief China economist and research director of REORIENT Securities Ltd of Hong Kong. He is a regular contributor to Asia Sentinel.)