YOUNG MONEY

China’s version of PayPal is mounting one of the biggest challenges to Chinese banks

July 3, 2014
July 3, 2014

This post has been corrected.

A little over a year ago, we argued that Yu’e Bao, the Alibaba-affiliated platform for money-market investment, could challenge the Chinese state-owned banks’ monopoly on savings deposits. The platform’s promise of higher yields capitalized on the backlash against the punishingly low, government-set deposit rates available to savers—a politically risky but potentially super-profitable gambit.

And, clearly, it has turned out to be both. In just a year, Yu’e Bao—which is owned by Alipay, the online payment platform that Alibaba Group spun off in 2011amassed 574.1 billion yuan ($92 billion) in assets. That makes it the Zeng Libao, the actual money-market fund in which Yu’e Bao invests its customers deposits, the biggest in China, and the fourth-largest in the world.

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Yu’e Bao’s astonishing growth makes it a huge force of “grassroots interest rate liberalization,” in the words of Bank of America/Merrill Lynch’s David Cui. So dangerous is that force to Chinese banks that the government has threatened a crackdown on Yu’e Bao, including limiting the amount users can transfer from their traditional bank accounts into the electronic payments system Alipay.

Though explicitly designed to allow people to earn interest off money sitting idle in their Alipay accounts between purchases from the company’s e-commerce site Taobao, enterprising early adopters appreciated both the higher yield and the ease with which they could manage their money via the Alipay smartphone app. So they began emptying their savings accounts and shoveling their money into Yu’e Bao. (Incidentally, since Yu’e Bao is provided through Alipay, which Alibaba no longer directly owns, it’s not a part of Alibaba’s planned IPO on the New York Stock Exchange.)

The overwhelming bulk of Yu’e Bao users are under the age of 30, according to Alibaba’s blog, Alizila. In a year, the average amount invested rose 17% to 5,030 yuan, even as Yu’e Bao’s rates of return, which fluctuate with China’s overall money-market rate, have come down a few percentage points. It’s now 4.22%; down from 6.3% a year ago. Still, significantly better than the government’s rate of 3.35%.

Part of the reason the rate has come down is the People’s Bank of China has been pumping money into the interbank market—that’s where banks lend each other money—to prevent a cash crunch like the one that happened in June of 2013 (more on that here). It’s through this market that Yu’e Bao makes money, loaning to deposit-scarce banks at much higher rates than the banks would ordinarily have to pay their depositors.

Put more simply, Yu’e Bao is in effect forcing banks to pay the market rate for deposits. And there you have it: “grassroots interest rate liberalization.”

But can Yu’e Bao really upend China’s financial system, when $92 billion is such a tiny fraction of the $16 trillion or so in traditional bank deposits?

Perhaps, according to Nicholas Borst of the Peterson Institute for International Economics, who recently wrote that internet finance “has the potential to be a large catalyst for reform and efficiency gains in China’s state-dominated financial system.” These funds have an outsize influence because they provide the liquidity that banks so desperately need.

“As last June’s credit crunch showed, China’s banks are deposit rich but liquidity poor,” Borst wrote. “Competition for deposits at the margin is fierce, demonstrated by the issuance of wealth management products [more on those here] and high bids for auctioned fiscal deposits. Internet funds represent a new competitor for end of quarter deposits that help banks meet their loan to deposit ratio requirement.”

Correction (July 3, 2014, 1:30 PM EST): An earlier version of this post incorrectly implied that Alibaba Group owns Yu’e Bao. Alipay owns both Yu’e Bao, the payment platform, and Zeng Libao, the money-market investment fund that is sold exclusively through Yu’e Bao. Alipay also owns a majority stake in Tianhong Asset Management, which runs Zengli Bao.

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