Fangs In: Yu E Bao Is Not to Blame; Criticism of Alibaba’s e-investment product is misguided because it represents exactly the kind of innovation the financial industry badly needs

02.24.2014 16:35

Fangs In: Yu E Bao Is Not to Blame

Criticism of Alibaba’s e-investment product is misguided because it represents exactly the kind of innovation the financial industry badly needs

By Liu Shengjun

Niu Wenxin, the executive editor of CCTV’s Stock Information Channel, recently called Alibaba’s e-investment product Yu E Bao a “vampire” in a blog article. He wrote that it should be banned because of the damages it does to banks, the financial industry and the country’s real economy.

It is understandable that some are feeling threatened by the sudden rise of a new force in the financial industry, in this case the Internet. Unlike the top-down reform plan of the third plenum of the Communist Party’s 18th Central Committee, the Internet is changing the country from the bottom up.

It took Yu E Bao a mere 200 days to grow from nothing to deposits of 250 billion yuan, and another 30 days to reach 400 billion yuan. The impressive growth echoes a warning from Alibaba CEO Jack Ma: “If the banks don’t change, we will change them.”

And it’s not just Alibaba’s Yu E Bao. Tencent Holdings’ Li Cai Tong and peer-to-peer online lending services sprouting up like bamboo in the spring all signal the disruptive change the Internet will force on the financial industry.

What made the sudden rise of Internet finance possible? We can look at the question from two perspectives.

Bombs Away

First, the success of Internet finance can be viewed as a result of overregulation. The current financial regulatory system is repressive. State-owned banks dominate, IPOs require licensing and the government sets interest rates. Overregulation has two consequences. On the one hand, banks are making loads of easy money while part of the real economy struggles to get financing. On the other, the financial system lacks the motivation to innovate. Plagued by low efficiency, the system fails to meet investors’ need for wealth management products and small and medium-sized enterprises’ need for financing.

But Alibaba’s service provides high yields for investors. On top of that, Yu E Bao is flexible, convenient and can be used for more than one purpose. (Customers can use money parked there to pay on Alibaba’s shopping websites). All of these factors contribute to Yu E Bao’s unrivalled success.

Second, Internet financing is ending discrimination that private businesses suffer. An interesting phenomenon is that almost all Internet finance companies are private. Therefore, the clash between them and banks is at the same time a clash between private and state-owned finance. For a long time, the financial industry was dominated by state-owned organizations with a few token private businesses. The Chinese dream of almost every private entrepreneur has been to build a bank that can get them out of the nightmare struggle to get financing. Yu E Bao is the bomb that tore down a part of state-owned capital’s great financial wall.

The sudden rise of Internet finance, seen from these perspectives, is threatening state banks’ long-time monopoly. Niu’s comments are precisely what the banks want to hear.

Remember Kodak?

Niu has two main arguments. The first is that Yu E Bao does not create any value on its own, but profits from raising the cost of credit for society. “Yu E Bao is a typical parasite of the financial system … The country’s real economy, which is ultimately the final loan takers, will pay,” Niu said.

Second, he argues that no developed economy has seen services like Yu E Bao prosper, including Japan, whose people are also savers. This is because regulators in developed economies are well aware of the harm Yu E Bao and the like can do to the overall economy, Niu argues.

Is Yu E Bao a parasite? Of course not. Yu E Bao offers investors a yield that is 20 times banks current deposit rate simply by channeling money to the interbank money market through Tianhong Asset Management Co. Alibaba and Tianhong both earn a profit in the process. Where does the profit come from? Obviously from squeezing the excess profits of banks. There is no regulation that bans Tianhong, a wealth management company, from investing in the interbank money market, so what is wrong with making money legally? After all, the high interbank rate is not Alibaba’s work.

It is true that Yu E Bao does not serve the real economy in this process. But investing in the interbank money market is only a temporary phase for Yu E Bao.

As it expands and the interbank rate falls, Alibaba will no doubt need to find more innovative ways to use its money. For example, buying loan products through asset securitization would indirectly serve the real economy’s financing needs. Alibaba has just begun to raise the curtain on its financial innovation. Therefore, we cannot view Yu E Bao’s current investment method as the only one it will ever have. We certainly should not define it as the parasite because of it.

What about the argument that Yu E Bao will raise financing costs for the real economy? Wrong.

Yu E Bao and other similar services have created a significant catfish effect, motivating banks to better themselves in the face of competition. Internet finance and banks are both providers of financial services. Fiercer competition among service providers will only benefit investors and borrowers.

If Yu E Bao really is a vampire that Niu suggests it is, the blood it sucks is banks’ excess profits. It is beyond question that as time passes and more innovation are introduced, both investors and borrowers will benefit from a more competitive financial industry. The room for improvement is substantial.

As for Niu’s question as to why no developed economy has a service like Yu E Bao, the answer is simple: because developed economies do not have fixed interest rates or discriminate against private business. In other financial systems, Yu E Bao would have few advantages.

Internet finance inevitably comes with certain risks and challenges to regulators, but it is also a positive force that China’s financial system has not seen for years. The third plenum urged developing “inclusive finance,” that is to say a financial system without discrimination. The nature of Internet finance is exactly inclusive. Some financial reform goals have been partially achieved by Internet finance.

Of course, in the near future Internet finance could be incorporated into the regulatory system, for example, through the issuing of licenses. As for the lofty position that large banks enjoy, to avoid the fate of Nokia and Kodak they should embrace the revolution.

The author is the deputy executive director at China Europe International Business School.