Alibaba's Yuebao online funds vendor and its rivals will help savers but won't hurt the banks
Within just six months, Yuebao, the partnership between China’s Alibaba, and a fund house, Tianhong Asset Management, raised 250 billion yuan (HK$318 billion) from millions of little guys to invest in money market funds and treasury bonds.
Other internet companies, such as Tencent and Sina.com, are launching similar services.
All of a sudden, the market is euphoric about the beginning of the end of China’s stodgy and bureaucratic banks. After all, these banks are predominantly state-controlled and have never been nice to the little guys.
A sleek new force coming out of nowhere to challenge the entrenched banks is an exciting development.
Except that this is just a story. The reality is that it is not easy to move the cheese of the Chinese banks. Not yet, at least. Let’s look at some inconvenient truths.
First of all, despite the hoopla, the 250 billion yuan is just 0.24 per cent of the banking sector’s total deposit base.
Second, none of these e-commerce companies and e-finance platforms has an established base of borrowers or banking skills. Moreover, they do not even have a lending licence.
Strictly speaking, the buying and selling of money market funds by Yuebao is a grey area in the regulatory framework. It is a clever innovation, and the regulators have so far turned a sympathetic eye to this borderline case. But if it somehow spreads like wildfire, the regulatory sympathy could evaporate.
Third, how is Yuebao – or other, similar operators – going to use the money it raises from the little guys? So far, its only investment options are money market funds, treasury bonds and bank deposits.
But money market funds must, in turn, invest the money somewhere, predominantly in bank deposits and treasury bonds. So, in a way, instead of competing with the banks, the likes of Yuebao are working for the banks.
Of course, the manoeuvre by the likes of Yuebao will raise the returns for the millions of little guys, but those returns will be capped by the willingness of the banks to accept the recycled money.
It is true that the work of Yuebao and rivals will push up the cost of funding for the entire banking industry, but the extent of that funding cost increase is totally dependent on the banks’ ability to pass the higher funding costs to borrowers.
On the face of it, the little guys are moving money from bank deposits to buy financial products. But given the size of the banking industry in China, the banks collectively determine the yields and prices of financial assets.
Finally, one must ask the question, why do Google and Amazon, for all their resources and popularity, not do in the United States what Yuebao is doing in China?
The reason is simple: the business model does not exist in the US. Why? It is because of the free-market interest rate regime.
But as much as one-quarter of the funding for China’s banks is already driven by market interest rates. That is the so-called wealth management products. In this particular segment, the banks actually make a higher interest margin, because, in addition to passing the higher funding costs to end users of the money, they charge multiple service fees and higher rates.
It is conceivable that in the next five to 10 years, all the funding sources of the banks will be subject to market rates, thanks to pressure from the likes of Yuebao.
The banks’ lending rates will move up in a parallel manner, with banks’ profitability either unchanged or even enhanced. As we approach that point, Yuebao and the like will gradually lose their relevance.
By then, they either become glorious martyrs for the Chinese interest rate liberalisation, invent something else or die a slow death.
At present, Yuebao and the like are harmless to the banks. When they start to move the banks’ cheese, the banks will fight back by simply raising interest rates, one way or another, to keep deposits and so eliminate the scope for the recycling of deposits.
The likes of Yuebao will still have their usefulness: pooling the money of the little guys to invest in treasury bonds and money market funds.
But that business model has no “moat”: the banks can do this for the millions of their customers at a tiny marginal cost. Thus far, they have not bothered to do it. But if the need arises, who is there to stop the banks from offering even better products, given their vast capabilities to cross-subsidise between various lines of business?
After all, investing in money market funds and treasury bonds is not risk-free. One wave of losses on the back of some volatility would be sufficient to cool the euphoria we have so far witnessed.
In conclusion, the likes of Yuebao are doing Chinese savers a great service. Their continued efforts will force the banks to gradually raise the interest rates on short-term deposits, one way or another, with the rate hike being officially sanctioned by the central bank or without.
As a result, the yield curve in the banking sector will experience a parallel shift upward. In the long term, that means a slowdown of total credit growth – and a more rational economy.
Joe Zhang is the author of Inside China’s Shadow Banking: The Next Subprime Crisis? and a corporate governance advisor in Hong Kong